[Title 26 CFR ]
[Code of Federal Regulations (annual edition) - April 1, 1997 Edition]
[From the U.S. Government Publishing Office]


          26



          Internal Revenue



[[Page i]]

          PART 1 (Secs. 1.641 TO 1.850)

          Revised as of April 1, 1997
          CONTAINING
          A CODIFICATION OF DOCUMENTS
          OF GENERAL APPLICABILITY
          AND FUTURE EFFECT

          AS OF APRIL 1, 1997
          With Ancillaries
          Published by
          the Office of the Federal Register
          National Archives and Records
          Administration

          as a Special Edition of
          the Federal Register



[[Page ii]]

                                      




                     U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 1997



               For sale by U.S. Government Printing Office
 Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328



[[Page iii]]




                            Table of Contents



                                                                    Page
  Explanation.................................................       v

  Title 26:
    Chapter I--Internal Revenue Service, Department of the 
        Treasury (Continued)..................................       3

  Finding Aids:
    Table of CFR Titles and Chapters..........................     679
    Alphabetical List of Agencies Appearing in the CFR........     695
    Table of OMB Control Numbers..............................     705
    List of CFR Sections Affected.............................     721

[[Page iv]]



      



                                                                                                                
                                  ----------------------------------------------------------                    

  Cite this Code:  CFR                                                         
                                                                                                                
  To cite the regulations in this volume use title, part                       
  and section number. Thus, 26 CFR 1.641(a)-0 refers to                       
  title 26, part 1, section 641(a)-0.                                         
                                  ----------------------------------------------------------                    
                                                                                                                


[[Page v]]

                               EXPLANATION

    The Code of Federal Regulations is a codification of the general and 
permanent rules published in the Federal Register by the Executive 
departments and agencies of the Federal Government. The Code is divided 
into 50 titles which represent broad areas subject to Federal 
regulation. Each title is divided into chapters which usually bear the 
name of the issuing agency. Each chapter is further subdivided into 
parts covering specific regulatory areas.
    Each volume of the Code is revised at least once each calendar year 
and issued on a quarterly basis approximately as follows:

Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
    The appropriate revision date is printed on the cover of each 
volume.

LEGAL STATUS

    The contents of the Federal Register are required to be judicially 
noticed (44 U.S.C. 1507). The Code of Federal Regulations is prima facie 
evidence of the text of the original documents (44 U.S.C. 1510).

HOW TO USE THE CODE OF FEDERAL REGULATIONS

    The Code of Federal Regulations is kept up to date by the individual 
issues of the Federal Register. These two publications must be used 
together to determine the latest version of any given rule.
    To determine whether a Code volume has been amended since its 
revision date (in this case, April 1, 1997), consult the ``List of CFR 
Sections Affected (LSA),'' which is issued monthly, and the ``Cumulative 
List of Parts Affected,'' which appears in the Reader Aids section of 
the daily Federal Register. These two lists will identify the Federal 
Register page number of the latest amendment of any given rule.

EFFECTIVE AND EXPIRATION DATES

    Each volume of the Code contains amendments published in the Federal 
Register since the last revision of that volume of the Code. Source 
citations for the regulations are referred to by volume number and page 
number of the Federal Register and date of publication. Publication 
dates and effective dates are usually not the same and care must be 
exercised by the user in determining the actual effective date. In 
instances where the effective date is beyond the cut-off date for the 
Code a note has been inserted to reflect the future effective date. In 
those instances where a regulation published in the Federal Register 
states a date certain for expiration, an appropriate note will be 
inserted following the text.

OMB CONTROL NUMBERS

    The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires 
Federal agencies to display an OMB control number with their information 
collection request.

[[Page vi]]

Many agencies have begun publishing numerous OMB control numbers as 
amendments to existing regulations in the CFR. These OMB numbers are 
placed as close as possible to the applicable recordkeeping or reporting 
requirements.

OBSOLETE PROVISIONS

    Provisions that become obsolete before the revision date stated on 
the cover of each volume are not carried. Code users may find the text 
of provisions in effect on a given date in the past by using the 
appropriate numerical list of sections affected. For the period before 
January 1, 1986, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, or 1973-1985, published in seven separate volumes. For 
the period beginning January 1, 1986, a ``List of CFR Sections 
Affected'' is published at the end of each CFR volume.

CFR INDEXES AND TABULAR GUIDES

    A subject index to the Code of Federal Regulations is contained in a 
separate volume, revised annually as of January 1, entitled CFR Index 
and Finding Aids. This volume contains the Parallel Table of Statutory 
Authorities and Agency Rules (Table I), and Acts Requiring Publication 
in the Federal Register (Table II). A list of CFR titles, chapters, and 
parts and an alphabetical list of agencies publishing in the CFR are 
also included in this volume.
    An index to the text of ``Title 3--The President'' is carried within 
that volume.
    The Federal Register Index is issued monthly in cumulative form. 
This index is based on a consolidation of the ``Contents'' entries in 
the daily Federal Register.
    A List of CFR Sections Affected (LSA) is published monthly, keyed to 
the revision dates of the 50 CFR titles.

REPUBLICATION OF MATERIAL

    There are no restrictions on the republication of material appearing 
in the Code of Federal Regulations.

INQUIRIES

    For a legal interpretation or explanation of any regulation in this 
volume, contact the issuing agency. The issuing agency's name appears at 
the top of odd-numbered pages.
    For inquiries concerning CFR reference assistance, call 202-523-5227 
or write to the Director, Office of the Federal Register, National 
Archives and Records Administration, Washington, DC 20408.
SALES

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                              Raymond A. Mosley,
                                    Director,
                          Office of the Federal Register.

April 1, 1997.



[[Page vii]]



                               THIS TITLE

    Title 26--Internal Revenue is composed of nineteen volumes. The 
contents of these volumes represent all current regulations issued by 
the Internal Revenue Service, Department of the Treasury, as of April 1, 
1997. The first twelve volumes comprise part 1 (Subchapter A--Income 
Tax) and are arranged by sections as follows: Secs. 1.0-1-1.60; 
Secs. 1.61-1.169; Secs. 1.170-1.300; Secs. 1.301-1.400; Secs. 1.401-
1.440; Secs. 1.441-1.500; Secs. 1.501-1.640; Secs. 1.641-1.850; 
Secs. 1.851-1.907; Secs. 1.908-1.1000; Secs. 1.1001-1.1400 and 
Sec. 1.1401 to end. The thirteenth volume containing parts 2-29, 
includes the remainder of subchapter A and all of Subchapter B--Estate 
and Gift Taxes. The last six volumes contain parts 30-39 (Subchapter C--
Employment Taxes and Collection of Income Tax at Source); parts 40-49; 
parts 50-299 (Subchapter D--Miscellaneous Excise Taxes); parts 300-499 
(Subchapter F--Procedure and Administration); parts 500-599 (Subchapter 
G--Regulations under Tax Conventions); and part 600 to end (Subchapter 
H--Internal Revenue Practice).

    The OMB control numbers for Title 26 appear in Sec. 602.101 of this 
chapter. For the convenience of the user, Sec. 602.101 appears in the 
Finding Aids section of the volumes containing parts 1 to 599.

    For this volume, Cheryl E. Sirofchuck was Chief Editor. The Code of 
Federal Regulations publication program is under the direction of 
Frances D. McDonald, assisted by Alomha S. Morris.

[[Page viii]]



 

[[Page 1]]



                       TITLE 26--INTERNAL REVENUE




            (This book contains part 1, Secs. 1.641 to 1.850)

  --------------------------------------------------------------------
                                                                    Part
Chapter i--Internal Revenue Service, Department of the 
  Treasury (Continued)......................................           1

[[Page 3]]



CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED)




                     (Part 1, Secs. 1.641 to 1.850)

  --------------------------------------------------------------------

  Editorial Notes: (1) IRS published a document at 45 FR 6088, Jan. 25, 
1980, deleting statutory sections from their regulations. In chapter I 
cross references to the deleted material have been changed to the 
corresponding sections of the IRS Code of 1954 or to the appropriate 
regulations sections. When either such change produced a redundancy, the 
cross reference has been deleted. For further explanation, see 45 FR 
20795, March 31, 1980.

  (2) The OMB control numbers for title 26 appear in Secs. 601.9000 and 
602.101 of this chapter. For the convenience of the user, Secs. 601.9000 
and 602.101 appear in the Finding Aids section of this volume.

                  SUBCHAPTER A--INCOME TAX (CONTINUED)
Part                                                                Page
1               Income taxes (Continued)....................           4

  Supplementary Publication: Internal Revenue Service Looseleaf 
Regulations System.
  Additional supplementary publications are issued covering Alcohol and 
Tobacco Tax Regulations, and Regulations Under Tax Conventions.

[[Page 4]]

                  SUBCHAPTER A--INCOME TAX (CONTINUED)

                   PART 1--INCOME TAXES (Continued)

                 Normal Taxes and Surtaxes (Continued)

              ESTATES, TRUSTS, BENEFICIARIES, AND DECEDENTS

                   Estates, Trusts, and Beneficiaries

            general rules for taxation of estates and trusts

      Sec.

                              1.641  [Reserved]
                              1.641(a)-0  Scope of Subchapter J.
                              1.641(a)-1  Imposition of tax; application 
                              of tax.
                              1.641(a)-2  Gross income of estates and 
                              trusts.
                              1.641(b)-1  Computation and payment of 
                              tax; deductions and credits of estates and 
                              trusts.
                              1.641(b)-2  Filing of returns and payment 
                              of the tax.
                              1.641(b)-3  Termination of estates and 
                              trusts.
                              1.642(a)(1)-1  Partially tax-exempt 
                              interest.
                              1.642(a)(2)-1  Foreign taxes.
                              1.642(a)(3)-1  Dividends received by an 
                              estate or trust.
                              1.642(a)(3)-2  Time of receipt of 
                              dividends by beneficiary.
                              1.642(a)(3)-3  Cross reference.
                              1.642(b)-1  Deduction for personal 
                              exemption.
                              1.642(c)-0  Effective dates.
                              1.642(c)-1  Unlimited deduction for 
                              amounts paid for a charitable purpose.
                              1.642(c)-2  Unlimited deduction for 
                              amounts permanently set aside for a 
                              charitable purpose.
                              1.642(c)-3  Adjustments and other special 
                              rules for determining unlimited charitable 
                              contributions deduction.
                              1.642(c)-4  Nonexempt private foundations.
                              1.642(c)-5  Definition of pooled income 
                              fund.
                              1.642(c)-6  Valuation of a remainder 
                              interest in property transferred to a 
                              pooled income fund after April 30, 1989.
                              1.642(c)-7  Transitional rules with 
                              respect to pooled income funds.
                              1.642(d)-1  Net operating loss deduction.
                              1.642(e)-1  Depreciation and depletion.
                              1.642(f)-1  Amortization deductions.
                              1.642(g)-1  Disallowance of double 
                              deductions; in general.
                              1.642(g)-2  Deductions included.
                              1.642(h)-1  Unused loss carryovers on 
                              termination of an estate or trust.
                              1.642(h)-2  Excess deductions on 
                              termination of an estate or trust.
                              1.642(h)-3  Meaning of ``beneficiaries 
                              succeeding to the property of the estate 
                              or trust''.
                              1.642(h)-4  Allocation.
                              1.642(h)-5  Example.
                              1.642(i)-1  Certain distributions by 
                              cemetery perpetual care funds.
                              1.642(i)-2  Definitions.
                              1.643(a)-0  Distributable net income; 
                              deduction for distributions; in general.
                              1.643(a)-1  Deduction for distributions.
                              1.643(a)-2  Deduction for personal 
                              exemption.
                              1.643(a)-3  Capital gains and losses.
                              1.643(a)-4  Extraordinary dividends and 
                              taxable stock dividends.
                              1.643(a)-5  Tax-exempt interest.
                              1.643(a)-6  Income of foreign trust.
                              1.643(a)-7  Dividends.
                              1.643(b)-1  Definition of ``income''.

[[Page 5]]

                              1.643(b)-2  Dividends allocated to corpus.
                              1.643(c)-1  Definition of ``beneficiary''.
                              1.643(d)-1  Definition of ``foreign trust 
                              created by a United States person''.
                              1.643(d)-2  Illustration of the provisions 
                              of section 643.

    Pooled Income Fund Actuarial Tables Applicable Before May 1, 1989

                              1.642(c)-6A  Valuation of charitable 
                              remainder interests for which the 
                              valuation date is before May 1, 1989.

               trusts which distribute current income only

                              1.651(a)-1  Simple trusts; deduction for 
                              distributions; in general.
                              1.651(a)-2  Income required to be 
                              distributed currently.
                              1.651(a)-3  Distribution of amounts other 
                              than income.
                              1.651(a)-4  Charitable purposes.
                              1.651(a)-5  Estates.
                              1.651(b)-1  Deduction for distributions to 
                              beneficiaries.
                              1.652(a)-1  Simple trusts; inclusion of 
                              amounts in income of beneficiaries.
                              1.652(a)-2  Distributions in excess of 
                              distributable net income.
                              1.652(b)-1  Character of amounts.
                              1.652(b)-2  Allocation of income items.
                              1.652(b)-3  Allocation of deductions.
                              1.652(c)-1  Different taxable years.
                              1.652(c)-2  Death of individual 
                              beneficiaries.
                              1.652(c)-3  Termination of existence of 
                              other beneficiaries.
                              1.652(c)-4  Illustration of the provisions 
                              of sections 651 and 652.

   estates and trusts which may accumulate income or which distribute 
                                 corpus

                              1.661(a)-1  Estates and trusts 
                              accumulating income or distributing 
                              corpus; general.
                              1.661(a)-2  Deduction for distributions to 
                              beneficiaries.
                              1.661(b)-1  Character of amounts 
                              distributed; in general.
                              1.661(b)-2  Character of amounts 
                              distributed when charitable contributions 
                              are made.
                              1.661(c)-1  Limitation on deduction.
                              1.661(c)-2  Illustration of the provisions 
                              of section 661.
                              1.662(a)-1  Inclusion of amounts in gross 
                              income of beneficiaries of estates and 
                              complex trusts; general.
                              1.662(a)-2  Currently distributable 
                              income.
                              1.662(a)-3  Other amounts distributed.
                              1.662(a)-4  Amounts used in discharge of a 
                              legal obligation.
                              1.662(b)-1  Character of amounts; when no 
                              charitable contributions are made.
                              1.662(b)-2  Character of amounts; when 
                              charitable contributions are made.
                              1.662(c)-1  Different taxable years.
                              1.662(c)-2  Death of individual 
                              beneficiary.
                              1.662(c)-3  Termination of existence of 
                              other beneficiaries.
                              1.662(c)-4  Illustration of the provisions 
                              of sections 661 and 662.
                              1.663(a)-1  Special rules applicable to 
                              sections 661 and 662; exclusions; gifts, 
                              bequests, etc.
                              1.663(a)-2  Charitable, etc., 
                              distributions.
                              1.663(a)-3  Denial of double deduction.
                              1.663(b)-1  Distributions in first 65 days 
                              of taxable year; scope.
                              1.663(b)-2  Election.
                              1.663(c)-1  Separate shares treated as 
                              separate trusts; in general.
                              1.663(c)-2  Computation of distributable 
                              net income.
                              1.663(c)-3  Applicability of separate 
                              share rule.
                              1.663(c)-4  Example.
                              1.664-1  Charitable remainder trusts.
                              1.664-2  Charitable remainder annuity 
                              trust.

[[Page 6]]

                              1.664-3  Charitable remainder unitrust.
                              1.664-4  Calculation of the fair market 
                              value of the remainder interest in a 
                              charitable remainder unitrust.
                              1.664-4A  Valuation of charitable 
                              remainder interests for which the 
                              valuation date is before May 1, 1989.
                              1.665(a)-0A  Excess distributions by 
                              trusts; scope of subpart D.
                              1.665(a)-1A  Undistributed net income.
                              1.665(b)-1A  Accumulation distributions.
                              1.665(b)-2A  Special rules for 
                              accumulation distributions made in taxable 
                              years beginning before January 1, 1974.
                              1.665(c)-1A  Special rule applicable to 
                              distributions by certain foreign trusts.
                              1.665(d)-1A  Taxes imposed on the trust.
                              1.665(e)-1A  Preceding taxable year.
                              1.665(f)-1A  Undistributed capital gain.
                              1.665(g)-1A  Capital gain distribution.
                              1.665(g)-2A  Application of separate share 
                              rule.

treatment of excess distributions by trusts applicable to taxable years 
                    beginning before january 1, 1969

                              1.665(a)-0  Excess distributions by 
                              trusts; scope of subpart D.
                              1.665(a)-1  Undistributed net income.
                              1.665(b)-1  Accumulation distributions of 
                              trusts other than certain foreign trusts; 
                              in general.
                              1.665(b)-2  Exclusions from accumulation 
                              distributions in the case of trusts (other 
                              than a foreign trust created by a U.S. 
                              person).
                              1.665(b)-3  Exclusions under section 
                              663(a) (1).
                              1.665(c)-1  Accumulation distributions of 
                              certain foreign trusts; in general.
                              1.665(c)-2  Indirect payments to the 
                              beneficiary.
                              1.665(d)-1  Taxes imposed on the trust.
                              1.665(e)-1  Preceding taxable year.
                              1.665(e)-2  Application of separate share 
                              rule.
                              1.666(a)-1A  Amount allocated.
                              1.666(b)-1A  Total taxes deemed 
                              distributed.
                              1.666(c)-1A  Pro rata portion of taxes 
                              deemed distributed.
                              1.666(c)-2A  Illustration of the 
                              provisions of section 666 (a), (b), and 
                              (c).
                              1.666(d)-1A  Information required from 
                              trusts.
                              1.666(a)-1  Amount allocated.
                              1.666(b)-1  Total taxes deemed 
                              distributed.
                              1.666(c)-1  Pro rata portion of taxes 
                              deemed distributed.
                              1.666(c)-2  Illustration of the provisions 
                              of section 666.
                              1.667-1  Denial of refund to trusts.
                              1.667(a)-1A  Denial of refund to trusts.
                              1.667(b)-1A  Authorization of credit to 
                              beneficiary for taxes imposed on the 
                              trust.
                              1.668(a)-1A  Amounts treated as received 
                              in prior taxable years; inclusion in gross 
                              income.
                              1.668(a)-2A  Allocation among 
                              beneficiaries; in general.
                              1.668(a)-3A  Determination of tax.
                              1.668(b)-1A  Tax on distribution.
                              1.668(b)-2A  Special rules applicable to 
                              section 668.
                              1.668(b)-3A  Computation of the 
                              beneficiary's income and tax for a prior 
                              taxable year.
                              1.668(b)-4A  Information requirements with 
                              respect to beneficiary.
                              1.668(a)-1  Amounts treated as received in 
                              prior taxable years; inclusion in gross 
                              income.
                              1.668(a)-2  Allocation among 
                              beneficiaries; in general.
                              1.668(a)-3  Excluded amounts.
                              1.668(a)-4  Tax attributable to throwback.
                              1.668(b)-1  Credit for taxes paid by the 
                              trust.
                              1.668(b)-2  Illustration of the provisions 
                              of subpart D.

[[Page 7]]

                              1.669(a)-1A  Amount allocated.
                              1.669(b)-1A  Tax on distribution.
                              1.669(c)-1A  Special rules applicable to 
                              section 669.
                              1.669(c)-2A  Computation of the 
                              beneficiary's income and tax for a prior 
                              taxable year.
                              1.669(c)-3A  Information requirements with 
                              respect to beneficiary.
                              1.669(d)-1A  Total taxes deemed 
                              distributed.
                              1.669(e)-1A  Pro rata portion of taxes 
                              deemed distributed.
                              1.669(e)-2A  Illustration of the 
                              provisions of section 669.
                              1.669(f)-1A  Character of capital gain.
                              1.669(f)-2A  Exception for capital gain 
                              distributions from certain trusts.
                              1.669(a)-1  Limitation on tax.
                              1.669(a)-2  Rules applicable to section 
                              669 computations.
                              1.669(a)-3  Tax computed by the exact 
                              throwback method.
                              1.669(a)-4  Tax attributable to short-cut 
                              throwback method.
                              1.669(b)-1  Information requirements.
                              1.669(b)-2  Manner of exercising election.

            grantors and others treated as substantial owners

                              1.671-1  Grantors and others treated as 
                              substantial owners; scope.
                              1.671-2  Applicable principles.
                              1.671-3  Attribution or inclusion of 
                              income, deductions, and credits against 
                              tax.
                              1.671-4  Method of reporting.
                              1.672(a)-1  Definition of adverse party.
                              1.672(b)-1  Nonadverse party.
                              1.672(c)-1  Related or subordinate party.
                              1.672(d)-1  Power subject to condition 
                              precedent.
                              1.673(a)-1  Reversionary interests; income 
                              payable to beneficiaries other than 
                              certain charitable organizations; general 
                              rule.
                              1.673(b)-1  Income payable to charitable 
                              beneficiaries (before amendment by Tax 
                              Reform Act of 1969).
                              1.673(c)-1  Reversionary interest after 
                              income beneficiary's death.
                              1.673(d)-1  Postponement of date specified 
                              for reacquisition.
                              1.674(a)-1  Power to control beneficial 
                              enjoyment; scope of section 674.
                              1.674(b)-1  Excepted powers exercisable by 
                              any person.
                              1.674(c)-1  Excepted powers exercisable 
                              only by independent trustees.
                              1.674(d)-1  Excepted powers exercisable by 
                              any trustee other than grantor or spouse.
                              1.674(d)-2  Limitations on exceptions in 
                              section 674 (b), (c), and (d).
                              1.675-1  Administrative powers.
                              1.676(a)-1  Power to revest title to 
                              portion of trust property in grantor; 
                              general rule.
                              1.676(b)-1  Powers exercisable only after 
                              a period of time.
                              1.677(a)-1  Income for benefit of grantor; 
                              general rule.
                              1.677(b)-1  Trusts for support.
                              1.678(a)-1  Person other than grantor 
                              treated as substantial owner; general 
                              rule.
                              1.678(b)-1  If grantor is treated as the 
                              owner.
                              1.678(c)-1  Trusts for support.
                              1.678(d)-1  Renunciation of power.

                              miscellaneous

                              1.681(a)-1  Limitation on charitable 
                              contributions deductions of trusts; scope 
                              of section 681.
                              1.681(a)-2  Limitation on charitable 
                              contributions deduction of trusts with 
                              trade or business income.
                              1.681(b)-1  Cross reference.
                              1.682(a)-1  Income of trust in case of 
                              divorce, etc.
                              1.682(b)-1  Application of trust rules to 
                              alimony payments.
                              1.682(c)-1  Definitions.

[[Page 8]]

                              1.683-1  Applicability of provisions; 
                              general rule.
                              1.683-2  Exceptions.
                              1.683-3  Application of the 65-day rule of 
                              the Internal Revenue Code of 1939.

                     income in respect of decedents

                              1.691(a)-1  Income in respect of a 
                              decedent.
                              1.691(a)-2  Inclusion in gross income by 
                              recipients.
                              1.691(a)-3  Character of gross income.
                              1.691(a)-4  Transfer of right to income in 
                              respect of a decedent.
                              1.691(a)-5  Installment obligations 
                              acquired from decedent.
                              1.691(b)-1  Allowance of deductions and 
                              credit in respect to decedents.
                              1.691(c)-1  Deduction for estate tax 
                              attributable to income in respect of a 
                              decedent.
                              1.691(c)-2  Estates and trusts.
                              1.691(d)-1  Amounts received by surviving 
                              annuitant under joint and survivor annuity 
                              contract.
                              1.691(e)-1  Installment obligations 
                              transmitted at death when prior law 
                              applied.
                              1.691(f)-1  Cross reference.
                              1.692-1  Abatement of income taxes of 
                              certain members of the Armed Forces of the 
                              United States upon death.

                        PARTNERS AND PARTNERSHIPS

                     Determination of Tax Liability

                              1.701-1  Partners, not partnership, 
                              subject to tax.
                              1.701-2  Anti-abuse rule.
                              1.702-1  Income and credits of partner.
                              1.702-2  Net operating loss deduction of 
                              partner.
                              1.702-3T  4-Year spread (temporary).
                              1.703-1  Partnership computations.
                              1.704-1  Partner's distributive share.
                              1.704-2  Allocations attributable to 
                              nonrecourse liabilities.
                              1.704-3  Contributed property.
                              1.704-4  Distribution of contributed 
                              property.
                              1.705-1  Determination of basis of 
                              partner's interest.
                              1.706-1  Taxable years of partner and 
                              partnership.
                              1.706-1T  Taxable years of certain 
                              partnerships (temporary).
                              1.706-2T  Temporary regulations; question 
                              and answer under the Tax Reform Act of 
                              1984.
                              1.706-3T  Temporary regulations under the 
                              Tax Reform Act of 1986 and the Revenue Act 
                              of 1987 (temporary).
                              1.707-0  Table of contents.
                              1.707-1  Transactions between partner and 
                              partnership.
                              1.707-2  Disguised payments for services. 
                              [Reserved]
                              1.707-3  Disguised sales of property to 
                              partnership; general rules.
                              1.707-4  Disguised sales of property to 
                              partnership; special rules applicable to 
                              guaranteed payments, preferred returns, 
                              operating cash flow distributions, and 
                              reimbursements of preformation 
                              expenditures.
                              1.707-5  Disguised sales of property to 
                              partnership; special rules relating to 
                              liabilities.
                              1.707-6  Disguised sales of property by 
                              partnership to partner; general rules.
                              1.707-7  Disguised sales of partnership 
                              interests. [Reserved]
                              1.707-8  Disclosure of certain 
                              information.
                              1.707-9  Effective dates and transitional 
                              rules.
                              1.708-1  Continuation of partnership.
                              1.709-1  Treatment of organization and 
                              syndication costs.
                              1.709-2  Definitions.

[[Page 9]]

               Contributions, Distributions, and Transfers

                     contributions to a partnership

                              1.721-1  Nonrecognition of gain or loss on 
                              contribution.
                              1.722-1  Basis of contributing partner's 
                              interest.
                              1.723-1  Basis of property contributed to 
                              partnership.

                     distributions by a partnership

                              1.731-1  Extent of recognition of gain or 
                              loss on distribution.
                              1.731-2  Partnership distributions of 
                              marketable securities.
                              1.732-1  Basis of distributed property 
                              other than money.
                              1.732-2  Special partnership basis of 
                              distributed property.
                              1.733-1  Basis of distributee partner's 
                              interest.
                              1.734-1  Optional adjustment to basis of 
                              undistributed partnership property.
                              1.734-2  Adjustment after distribution to 
                              transferee partner.
                              1.735-1  Character of gain or loss on 
                              disposition of distributed property.
                              1.736-1  Payments to a retiring partner or 
                              a deceased partner's successor in 
                              interest.
                              1.737-1  Recognition of precontribution 
                              gain.
                              1.737-2  Exceptions and special rules.
                              1.737-3  Basis adjustments; Recovery 
                              rules.
                              1.737-4  Anti-abuse rule.
                              1.737-5  Effective date.

                 transfers of interests in a partnership

                              1.741-1  Recognition and character of gain 
                              or loss on sale or exchange.
                              1.742-1  Basis of transferee partner's 
                              interest.
                              1.743-1  Optional adjustment to basis of 
                              partnership property.

    provisions common to part ii, subchapter k, chapter 1 of the code

                              1.751-1  Unrealized receivables and 
                              inventory items.
                              1.752-0  Table of Contents.
                              1.752-1  Treatment of partnership 
                              liabilities.
                              1.752-2  Partner's share of resource 
                              liabilities.
                              1.752-3  Partner's share of nonrecourse 
                              liabilities.
                              1.752-4  Special rules.
                              1.752-5  Effective dates and transition 
                              rules.
                              1.753-1  Partner receiving income in 
                              respect of decedent.
                              1.754-1  Time and manner of making 
                              election to adjust basis of partnership 
                              property.
                              1.755-1  Rules for allocation of basis.
                              1.755-2T  Coordination of sections 755 and 
                              1060 (temporary).

                               definitions

                              1.761-1  Terms defined.
                              1.761-2  Exclusion of certain 
                              unincorporated organizations from the 
                              application of all or part of subchapter K 
                              of chapter 1 of the Internal Revenue Code.

         Effective Date for subchapter K, chapter 1 of the Code

                              1.771-1  Effective date.

                           INSURANCE COMPANIES

                        Life Insurance Companies

                         definition; tax imposed

                              1.801-1  Definitions.
                              1.801-2  Taxable years affected.

[[Page 10]]

                              1.801-3  Definitions.
                              1.801-4  Life insurance reserves.
                              1.801-5  Total reserves.
                              1.801-6  Adjustments in reserves for 
                              policy loans.
                              1.801-7  Variable annuities.
                              1.801-8  Contracts with reserves based on 
                              segregated asset accounts.
                              1.802(b)-1  Tax on life insurance 
                              companies.
                              1.802-2  Taxable years affected.
                              1.802-3  Tax imposed on life insurance 
                              companies.
                              1.802-4  Life insurance company taxable 
                              income.
                              1.802-5  Special rule for 1959 and 1960.
                              1.803-1  Life insurance reserves.
                              1.803-2  Adjusted reserves.
                              1.803-3  Interest paid or accrued.
                              1.803-4  Taxable income and deductions.
                              1.803-5  Real estate owned and occupied.
                              1.803-6  Amortization of premium and 
                              accrual of discount.
                              1.803-7  Taxable years affected.

                            investment income

                              1.804-3  Gross investment income of a life 
                              insurance company.
                              1.804-4  Investment yield of a life 
                              insurance company.
                              1.806-1  Adjustment for certain reserves.
                              1.806-2  Taxable years affected.
                              1.806-3  Certain changes in reserves and 
                              assets.
                              1.806-4  Change of basis in computing 
                              reserves.
                              1.807-1  Mortality and morbidity tables.

                      gain and loss from operations

                              1.809-1  Taxable years affected.
                              1.809-2  Exclusion of share of investment 
                              yield set aside for policyholders.
                              1.809-3  Gain and loss from operations 
                              defined.
                              1.809-4  Gross amount.
                              1.809-5  Deductions.
                              1.809-6  Modifications.
                              1.809-7  Limitation on certain deductions.
                              1.809-8  Limitation on deductions for 
                              certain mutualization distributions.
                              1.809-9  Computation of the differential 
                              earnings rate and the recomputed 
                              differential earnings rate.
                              1.809-10  Computation of equity base.
                              1.810-1  Taxable years affected.
                              1.810-2  Rules for certain reserves.
                              1.810-3  Adjustment for change in 
                              computing reserves.
                              1.810-4  Certain decreases in reserves of 
                              voluntary employees' beneficiary 
                              associations.
                              1.811-1  Taxable years affected.
                              1.811-2  Dividends to policyholders.
                              1.812-1  Taxable years affected.
                              1.812-2  Operations loss deduction.
                              1.812-3  Computation of loss from 
                              operations.
                              1.812-4  Operations loss carrybacks and 
                              operations loss carryovers.
                              1.812-5  Offset.
                              1.812-6  New company defined.
                              1.812-7  Application of subtitle A and 
                              subtitle F.
                              1.812-8  Illustration of operations loss 
                              carrybacks and carryovers.

                      distributions to shareholders

                              1.815-1  Taxable years affected.

[[Page 11]]

                              1.815-2  Distributions to shareholders.
                              1.815-3  Shareholders surplus account.
                              1.815-4  Policyholders surplus account.
                              1.815-5  Other accounts defined.
                              1.815-6  Special rules.

                        miscellaneous provisions

                              1.817-1  Taxable years affected.
                              1.817-2  Treatment of capital gains and 
                              losses.
                              1.817-3  Gain on property held on December 
                              31, 1958, and certain substituted property 
                              acquired after 1958.
                              1.817-4  Special rules.
                              1.817-5  Diversification requirements for 
                              variable annuity, endowment, and life 
                              insurance contracts.
                              1.818-1  Taxable years affected.
                              1.818-2  Accounting provisions.
                              1.818-3  Amortization of premium and 
                              accrual of discount.
                              1.818-4  Election with respect to life 
                              insurance reserves computed on preliminary 
                              term basis.
                              1.818-5  Short taxable years.
                              1.818-6  Transitional rule for change in 
                              method of accounting.
                              1.818-7  Denial of double deductions.
                              1.818-8  Special rules relating to 
                              consolidated returns and certain capital 
                              losses.
                              1.819-1  Taxable years affected.
                              1.819-2  Foreign life insurance companies.

mutual insurance companies (other than life and certain marine insurance 
     companies and other than fire or flood insurance companies which 
        operate on basis of perpetual policies or premium deposits)



                              1.821-1  Tax on mutual insurance companies 
                              other than life or marine or fire 
                              insurance companies subject to the tax 
                              imposed by section 831.
                              1.821-2  Taxable years affected.
                              1.821-3  Tax on mutual insurance companies 
                              other than life or marine or fire 
                              insurance companies subject to the tax 
                              imposed by section 831.
                              1.821-4  Tax on mutual insurance companies 
                              other than life insurance companies and 
                              other than fire, flood, or marine 
                              insurance companies, subject to tax 
                              imposed by section 831.
                              1.821-5  Special transitional underwriting 
                              loss.
                              1.822-1  Taxable income and deductions.
                              1.822-2  Real estate owned and occupied.
                              1.822-3  Amortization of premium and 
                              accrual of discount.
                              1.822-4  Taxable years affected.
                              1.822-5  Mutual insurance company taxable 
                              income.
                              1.822-6  Real estate owned and occupied.
                              1.822-7  Amortization of premium and 
                              accrual of discount.
                              1.822-8  Determination of taxable 
                              investment income.
                              1.822-9  Real estate owned and occupied.
                              1.822-10  Amortization of premium and 
                              accrual of discount.
                              1.822-11  Net premiums.
                              1.822-12  Dividends to policyholders.
                              1.823-1  Net premiums.
                              1.823-2  Dividends to policyholders.
                              1.823-3  Taxable years affected.
                              1.823-4  Net premiums.
                              1.823-5  Dividends to policyholders.
                              1.823-6  Determination of statutory 
                              underwriting income or loss.
                              1.823-7  Subscribers of reciprocal 
                              underwriters and interinsurers.
                              1.823-8  Special transitional underwriting 
                              loss; cross reference.

[[Page 12]]

                              1.825-1  Unused loss deduction; in 
                              general.
                              1.825-2  Unused loss carryovers and 
                              carrybacks.
                              1.825-3  Examples.
                              1.826-1  Election by reciprocal 
                              underwriters and interinsurers.
                              1.826-2  Special rules applicable to 
                              electing reciprocals.
                              1.826-3  Attorney-in-fact of electing 
                              reciprocals.
                              1.826-4  Allocation of expenses.
                              1.826-5  Attribution of tax.
                              1.826-6  Credit or refund.
                              1.826-7  Examples.

                        other insurance companies

                              1.831-1  Tax on insurance companies (other 
                              than life or mutual), mutual marine 
                              insurance companies, and mutual fire 
                              insurance companies issuing perpetual 
                              policies.
                              1.831-2  Taxable years affected.
                              1.831-3  Tax on insurance companies (other 
                              than life or mutual), mutual marine 
                              insurance companies, mutual fire insurance 
                              companies issuing perpetual policies, and 
                              mutual fire or flood insurance companies 
                              operating on the basis of premium 
                              deposits; taxable years beginning after 
                              December 31, 1962.
                              1.831-4  Election of multiple line 
                              companies to be taxed on total income.
                              1.832-1  Gross income.
                              1.832-2  Deductions.
                              1.832-3  Taxable years affected.
                              1.832-4  Gross income.
                              1.832-5  Deductions.
                              1.832-6  Policyholders of mutual fire or 
                              flood insurance companies operating on the 
                              basis of premium deposits.
                              1.832-7T  Treatment of salvage and 
                              reinsurance in computing ``losses 
                              incurred'' deduction, taxable years 
                              beginning before January 1, 1990 
                              (temporary).
                              1.846-0  Outline of provisions.
                              1.846-1  Application of discount factors.
                              1.846-2  Election by taxpayer to use its 
                              own historical loss payment pattern.
                              1.846-3  Fresh start and reserve 
                              strengthening.
                              1.846-4  Effective date.
                              1.848-0  Outline of regulations under 
                              section 848.
                              1.848-1  Definitions and special 
                              provisions.
                              1.848-2  Determination of net premiums.
                              1.848-3  Interim rules for certain 
                              reinsurance agreements.

  Authority: 26 U.S.C. 7805, unless otherwise noted.

  Section 1.701-2 also issued under 26 U.S.C. 701 through 761.
  Section 1.704-3 also issued under 26 U.S.C. 704(c).
  Section 1.704-3T also issued under 26 U.S.C. 704(c).
  Section 1.704-4 also issued under 26 U.S.C. 704(c).
  Section 1.706-1T also issued under 26 U.S.C. 706(b).
  Sections 1.707-2 through 1.707-9 also issued under 26 U.S.C. 
707(a)(2).
  Section 1.721-1 also issued under 26 U.S.C. 721.
  Section 1.731-2 also issued under 26 U.S.C. 731(c).
  Section 1.761-2 also issued under 26 U.S.C. 446(b) and 26 U.S.C. 
761(a).
  Section 1.809-10 also issued under 26 U.S.C. 809(b)(2) and (g)(3).
  Section 1.832-4 also issued under 26 U.S.C. 832(b)(5)(A).
  Sections 1.846-1 through 1.846-4 also issued under 26 U.S.C. 846.
  Section 1.848-2 also issued under 26 U.S.C. 845(b) and 26 U.S.C. 
848(d)(4)(B).
  Section 1.848-3 also issued under 26 U.S.C. 848(d)(4)(B).

  Source: T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 
1960, unless otherwise noted.

[[Page 13]]



ESTATES, TRUSTS, BENEFICIARIES, AND DECEDENTS--Table of Contents




                   Estates, Trusts, and Beneficiaries

            general rules for taxation of estates and trusts

Sec. 1.641  [Reserved]



Sec. 1.641(a)-0   Scope of subchapter J.

    (a) In general. Subchapter J (sections 641 and following), chapter 1 
of the Code, deals with the taxation of income of estates and trusts and 
their beneficiaries, and of income in respect of decedents. Part I of 
subchapter J contains general rules for taxation of estates and trusts 
(subpart A), specific rules relating to trusts which distribute current 
income only (subpart B), estates and trusts which may accumulate income 
or which distribute corpus (subpart C), treatment of excess 
distributions by trusts (subpart D), grantors and other persons treated 
as substantial owners (subpart E), and miscellaneous provisions relating 
to limitations on charitable deductions, income of an estate or trust in 
case of divorce, and taxable years to which the provisions of subchapter 
J are applicable (subpart F). Part I has no application to any 
organization which is not to be classified for tax purposes as a trust 
under the classification rules of Secs. 301.7701-2, 301.7701-3, and 
301.7701-4 of this chapter (Regulations on Procedure and 
Administration). Part II of subchapter J relates to the treatment of 
income in respect of decedents. However, the provisions of subchapter J 
do not apply to employee trusts subject to subchapters D and F, chapter 
1 of the Code, and common trust funds subject to subchapter H, chapter 1 
of the Code.
    (b) Scope of subparts A, B, C, and D. Subparts A, B, C, and D 
(section 641 and following), part I, subchapter J, chapter 1 of the 
Code, relate to the taxation of estates and trusts and their 
beneficiaries. These subparts have no application to any portion of the 
corpus or income of a trust which is to be regarded, within the meaning 
of the Code, as that of the grantor or others treated as its substantial 
owners. See subpart E (section 671 and following), Part I, subchapter J, 
chapter 1 of the Code, and the regulations thereunder for rules for the 
treatment of any portion of a trust where the grantor (or another 
person) is treated as the substantial owner. So-called alimony trusts 
are treated under subparts A, B, C, and D, except to the extent 
otherwise provided in section 71 or section 682. These subparts have no 
application to beneficiaries of nonexempt employees' trusts. See section 
402(b) and the regulations thereunder.
    (c) Multiple trusts. Multiple trusts that have:
    (1) No substantially independent purposes (such as independent 
dispositive purposes),
    (2) The same grantor and substantially the same beneficiary, and
    (3) The avoidance or mitigation of (i) the progressive rates of tax 
(including mitigation as a result of deferral of tax) or (ii) the 
minimum tax for tax preferences imposed by section 56 as their principal 
purpose,

shall be consolidated and treated as one trust for the purposes of 
subchapter J.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
731, Jan. 17, 1969; T.D. 7204, 37 FR 17158, Aug. 25, 1972]



Sec. 1.641(a)-1   Imposition of tax; application of tax.

    For taxable years beginning after December 31, 1970, section 641 
prescribes that the taxes imposed by section 1(d), as amended by the Tax 
Reform Act of 1969, shall apply to the income of estates or of any kind 
of property held in trust. For taxable years ending before January 1, 
1971, section 641 prescribes that the taxes imposed upon individuals by 
chapter 1 of the Code apply to the income of estates or of any kind of 
property held in trust. The rates of tax, the statutory provisions 
respecting gross income, and, with certain exceptions, the deductions 
and credits allowed to individuals apply also to estates and trust.

[T.D. 7117, 36 FR 9421, May 25, 1971]



Sec. 1.641(a)-2   Gross income of estates and trusts.

    The gross income of an estate or trust is determined in the same 
manner as that of an individual. Thus, the

[[Page 14]]

gross income of an estate or trust consists of all items of gross income 
received during the taxable year, including:
    (a) Income accumulated in trust for the benefit of unborn or 
unascertained persons or persons with contingent interests;
    (b) Income accumulated or held for future distribution under the 
terms of the will or trust;
    (c) Income which is to be distributed currently by the fiduciary to 
the beneficiaries, and income collected by a guardian of an infant which 
is to be held or distributed as the court may direct;
    (d) Income received by estates of deceased persons during the period 
of administration or settlement of the estate; and
    (e) Income which, in the discretion of the fiduciary, may be either 
distributed to the beneficiaries or accumulated. The several classes of 
income enumerated in this section do not exclude others which also may 
come within the general purposes of section 641.



Sec. 1.641(b)-1   Computation and payment of tax; deductions and credits of estates and trusts.

    Generally, the deductions and credits allowed to individuals are 
also allowed to estates and trusts. However, there are special rules for 
the computation of certain deductions and for the allocation between the 
estate or trust and the beneficiaries of certain credits and deductions. 
See section 642 and the regulations thereunder. In addition, an estate 
or trust is allowed to deduct, in computing its taxable income, the 
deductions provided by sections 651 and 661 and regulations thereunder, 
relating to distributions to beneficiaries.



Sec. 1.641(b)-2   Filing of returns and payment of the tax.

    (a) The fiduciary is required to make and file the return and pay 
the tax on the taxable income of an estate or of a trust. Liability for 
the payment of the tax on the taxable income of an estate attaches to 
the person of the executor or administrator up to and after his 
discharge if, prior to distribution and discharge, he had notice of his 
tax obligations or failed to exercise due diligence in ascertaining 
whether or not such obligations existed. For the extent of such 
liability, see section 3467 of the Revised Statutes, as amended by 
section 518 of the Revenue Act of 1934 (31 U. S. C. 192). Liability for 
the tax also follows the assets of the estate distributed to heirs, 
devisees, legatees, and distributees, who may be required to discharge 
the amount of the tax due and unpaid to the extent of the distributive 
shares received by them. See section 6901. The same considerations apply 
to trusts.
    (b) The estate of an infant, incompetent, or other person under a 
disability, or, in general, of an individual or corporation in 
receivership or a corporation in bankruptcy is not a taxable entity 
separate from the person for whom the fiduciary is acting, in that 
respect differing from the estate of a deceased person or of a trust. 
See section 6012(b) (2) and (3) for provisions relating to the 
obligation of the fiduciary with respect to returns of such persons.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6580, 26 FR 
11486, Dec. 5, 1961]



Sec. 1.641(b)-3   Termination of estates and trusts.

    (a) The income of an estate of a deceased person is that which is 
received by the estate during the period of administration or 
settlement. The period of administration or settlement is the period 
actually required by the administrator or executor to perform the 
ordinary duties of administration, such as the collection of assets and 
the payment of debts, taxes, legacies, and bequests, whether the period 
required is longer or shorter than the period specified under the 
applicable local law for the settlement of estates. For example, where 
an executor who is also named as trustee under a will fails to obtain 
his discharge as executor, the period of administration continues only 
until the duties of administration are complete and he actually assumes 
his duties as trustee, whether or not pursuant to a court order. 
However, the period of administration of an estate cannot be unduly 
prolonged. If the administration of an estate is unreasonably

[[Page 15]]

prolonged, the estate is considered terminated for Federal income tax 
purposes after the expiration of a reasonable period for the performance 
by the executor of all the duties of administration. Further, an estate 
will be considered as terminated when all the assets have been 
distributed except for a reasonable amount which is set aside in good 
faith for the payment of unascertained or contingent liabilities and 
expenses (not including a claim by a beneficiary in the capacity of 
beneficiary).
    (b) Generally, the determination of whether a trust has terminated 
depends upon whether the property held in trust has been distributed to 
the persons entitled to succeed to the property upon termination of the 
trust rather than upon the technicality of whether or not the trustee 
has rendered his final accounting. A trust does not automatically 
terminate upon the happening of the event by which the duration of the 
trust is measured. A reasonable time is permitted after such event for 
the trustee to perform the duties necessary to complete the 
administration of the trust. Thus, if under the terms of the governing 
instrument, the trust is to terminate upon the death of the life 
beneficiary and the corpus is to be distributed to the remainderman, the 
trust continues after the death of the life beneficiary for a period 
reasonably necessary to a proper winding up of the affairs of the trust. 
However, the winding up of a trust cannot be unduly postponed and if the 
distribution of the trust corpus is unreasonably delayed, the trust is 
considered terminated for Federal income tax purposes after the 
expiration of a reasonable period for the trustee to complete the 
administration of the trust. Further, a trust will be considered as 
terminated when all the assets have been distributed except for a 
reasonable amount which is set aside in good faith for the payment of 
unascertained or contingent liabilities and expenses (not including a 
claim by a beneficiary in the capacity of beneficiary).
    (c)(1) Except as provided in subparagraph (2) of this paragraph, 
during the period between the occurrence of an event which causes a 
trust to terminate and the time when the trust is considered as 
terminated under this section, whether or not the income and the excess 
of capital gains over capital losses of the trust are to be considered 
as amounts required to be distributed currently to the ultimate 
distributee for the year in which they are received depends upon the 
principles stated in Sec. 1.651(a)-2. See Sec. 1.663-1 et seq. for 
application of the separate share rule.
    (2)(i) Except in cases to which the last sentence of this 
subdivision applies, for taxable years of a trust ending before 
September 1, 1957, subparagraph (1) of this paragraph shall not apply 
and the rule of subdivision (ii) of this subparagraph shall apply unless 
the trustee elects to have subparagraph (1) of this paragraph apply. 
Such election shall be made by the trustee in a statement filed on or 
before April 15, 1959, with the district director with whom such trust's 
return for any such taxable year was filed. The election provided by 
this subdivision shall not be available if the treatment given the 
income and the excess of capital gains over capital losses for taxable 
years for which returns have been filed was consistent with the 
provisions of subparagraph (1) of this paragraph.
    (ii) The rule referred to in subdivision (i) of this subparagraph is 
as follows: During the period between the occurrence of an event which 
causes a trust to terminate and the time when a trust is considered as 
terminated under this section, the income and the excess of capital 
gains over capital losses of the trust are in general considered as 
amounts required to be distributed for the year in which they are 
received. For example, a trust instrument provides for the payment of 
income to A during her life, and upon her death for the payment of the 
corpus to B. The trust reports on the basis of the calendar year. A dies 
on November 1, 1955, but no distribution is made to B until January 15, 
1956. The income of the trust and the excess of capital gains over 
capital losses for the entire year 1955, to the extent not paid, 
credited, or required to be distributed to A or A's estate, are treated 
under sections 661 and 662 as amounts required to be distributed to B 
for the year 1955.
    (d) If a trust or the administration or settlement of an estate is 
considered

[[Page 16]]

terminated under this section for Federal income tax purposes (as for 
instance, because administration has been unduly prolonged), the gross 
income, deductions, and credits of the estate or trust are, subsequent 
to the termination, considered the gross income, deductions, and credits 
of the person or persons succeeding to the property of the estate or 
trust.



Sec. 1.642(a)(1)-1   Partially tax-exempt interest.

    An estate or trust is allowed the credit against tax for partially 
tax-exempt interest provided by section 35 only to the extent that the 
credit does not relate to interest properly allocable to a beneficiary 
under section 652 or 662 and the regulations thereunder. A beneficiary 
of an estate or trust is allowed the credit against tax for partially 
tax-exempt interest provided by section 35 only to the extent that the 
credit relates to interest properly allocable to him under section 652 
or 662 and the regulations thereunder. If an estate or trust holds 
partially tax-exempt bonds and elects under section 171 to treat the 
premium on the bonds as amortizable, the credit allowable under section 
35, with respect to the bond interest (whether allowable to the estate 
or trust or to the beneficiary), is reduced under section 171(a)(3) by 
reducing the shares of the interest allocable, respectively, to the 
estate or trust and its beneficiary by the portion of the amortization 
deduction attributable to the shares.



Sec. 1.642(a)(2)-1   Foreign taxes.

    An estate or trust is allowed the credit against tax for taxes 
imposed by foreign countries and possessions of the United States to the 
extent allowed by section 901 only for so much of those taxes as are not 
properly allocable under that section to the beneficiaries. See section 
901(b)(4). For purposes of section 901(b)(4), the term beneficiaries 
includes charitable beneficiaries.



Sec. 1.642(a)(3)-1   Dividends received by an estate or trust.

    An estate or trust is allowed a credit against the tax for dividends 
received on or before December 31, 1964 (see section 34), only for so 
much of the dividends as are not properly allocable to any beneficiary 
under section 652 or 662. Section 642(a)(3), and this section do not 
apply to amounts received as dividends after December 31, 1964. For 
treatment of the credit in the hands of the beneficiary see 
Sec. 1.652(b)-1.

[T.D. 6777, 29 FR 17808, Dec. 16, 1964]



Sec. 1.642(a)(3)-2   Time of receipt of dividends by beneficiary.

    In general, dividends are deemed received by a beneficiary in the 
taxable year in which they are includible in his gross income under 
section 652 or 662. For example, a simple trust, reporting on the basis 
of a fiscal year ending October 30, receives quarterly dividends on 
November 3, 1954, and February 3, May 3, and August 3, 1955. These 
dividends are all allocable to beneficiary A, reporting on a calendar 
year basis, under section 652 and are deemed received by A in 1955. See 
section 652(c). Accordingly, A may take all these dividends into account 
in determining his credit for dividends received under section 34 and 
his dividends exclusion under section 116. However, solely for purposes 
of determining whether dividends deemed received by individuals from 
trusts or estates qualify under the time limitations of section 34(a) or 
section 116(a), section 642(a)(3) provides that the time of receipt of 
the dividends by the trust or estate is also considered the time of 
receipt by the beneficiary. For example, a simple trust reporting on the 
basis of a fiscal year ending October 30 receives quarterly dividends on 
December 3, 1953, and March 3, June 3, and September 3, 1954. These 
dividends are all allocable to beneficiary A, reporting on the calendar 
year basis, under section 652 and are includible in his income for 1954. 
However, for purposes of section 34(a) or section 116(a), these 
dividends are deemed received by A on the same dates that the trust 
received them. Accordingly, A may take into account in determining the 
credit under section 34 only those dividends received by the trust on 
September 3, 1954, since the dividend received credit is not allowed 
under section 34 for dividends received before August 1, 1954 (or after 
December 31, 1964). Section 642(a)(3) and this

[[Page 17]]

section do not apply to amounts received by an estate or trust as 
dividends after December 31, 1964. However, the rules in this section 
relating to time of receipt of dividends by a beneficiary are applicable 
to dividends received by an estate or trust prior to January 1, 1965, 
and accordingly, such dividends are deemed to be received by the 
beneficiary (even though received after December 31, 1964) on the same 
dates that the estate or trust received them for purposes of determining 
the credit under section 34 or the exclusion under section 116.

[T.D. 6777, 29 FR 17808, Dec. 16, 1964]



Sec. 1.642(a)(3)-3   Cross reference.

    See Sec. 1.683-2(c) for examples relating to the treatment of 
dividends received by an estate or trust during a fiscal year beginning 
in 1953 and ending in 1954.



Sec. 1.642(b)-1   Deduction for personal exemption.

    In lieu of the deduction for personal exemptions provided by section 
151:
    (a) An estate is allowed a deduction of $600,
    (b) A trust which, under its governing instrument, is required to 
distribute currently all of its income for the taxable year is allowed a 
deduction of $300, and
    (c) All other trusts are allowed a deduction of $100.

A trust which, under its governing instrument, is required to distribute 
all of its income currently is allowed a deduction of $300, even though 
it also distributes amounts other than income in the taxable year and 
even though it may be required to make distributions which would qualify 
for the charitable contributions deduction under section 642(c) (and 
therefore does not qualify as a ``simple trust'' under sections 651-
652). A trust for the payment of an annuity is allowed a deduction of 
$300 in a taxable year in which the amount of the annuity required to be 
paid equals or exceeds all the income of the trust for the taxable year. 
For the meaning of the term income required to be distributed currently, 
see Sec. 1.651(a)-2.



Sec. 1.642(c)-0   Effective dates.

    The provisions of section 642(c) (other than section 642(c)(5)) and 
of Secs. 1.642 (c)-1 through 1.642(c)-4 apply to amounts paid, 
permanently set aside, or to be used for a charitable purpose in taxable 
years beginning after December 31, 1969. The provisions of section 
642(c)(5) and of Secs. 1.642(c)-5 through 1.642(c)-7 apply to transfers 
in trust made after July 31, 1969. For provisions relating to amounts 
paid, permanently set aside, or to be used for a charitable purpose in 
taxable years beginning before January 1, 1970, see 26 CFR 1.642(c)-1 
through 1.642(c)-4 (Rev. as of Jan. 1, 1971).

[T.D. 7357, 40 FR 23739, June 2, 1975]



Sec. 1.642(c)-1   Unlimited deduction for amounts paid for a charitable purpose.

    (a) In general. (1) Any part of the gross income of an estate, or 
trust which, pursuant to the terms of the governing instrument is paid 
(or treated under paragraph (b) of this section as paid) during the 
taxable year for a purpose specified in section 170(c) shall be allowed 
as a deduction to such estate or trust in lieu of the limited charitable 
contributions deduction authorized by section 170(a). In applying this 
paragraph without reference to paragraph (b) of this section, a 
deduction shall be allowed for an amount paid during the taxable year in 
respect of gross income received in a previous taxable year, but only if 
no deduction was allowed for any previous taxable year for the amount so 
paid.
    (2) In determining whether an amount is paid for a purpose specified 
in section 170(c)(2) the provisions of section 170(c)(2)(A) shall not be 
taken into account. Thus, an amount paid to a corporation, trust, or 
community chest, fund, or foundation otherwise described in section 
170(c)(2) shall be considered paid for a purpose specified in section 
170(c) even though the corporation, trust, or community chest, fund, or 
foundation is not created or organized in the United States, any State, 
the District of Columbia, or any possession of the United States.
    (3) See section 642(c)(6) and Sec. 1.642(c)-4 for disallowance of a 
deduction under

[[Page 18]]

this section to a trust which is, or is treated under section 4947(a)(1) 
as though it were a private foundation (as defined in section 509(a) and 
the regulations thereunder) and not exempt from taxation under section 
501(a).
    (b) Election to treat contributions as paid in preceding taxable 
year--(1) In general. For purposes of determining the deduction allowed 
under paragraph (a) of this section, the fiduciary (as defined in 
section 7701(a)(6)) of an estate or trust may elect under section 
642(c)(1) to treat as paid during the taxable year (whether or not such 
year begins before January 1, 1970) any amount of gross income received 
during such taxable year or any preceding taxable year which is 
otherwise deductible under such paragraph and which is paid after the 
close of such taxable year but on or before the last day of the next 
succeeding taxable year of the estate or trust. The preceding sentence 
applies only in the case of payments actually made in a taxable year 
which is a taxable year beginning after December 31, 1969. No election 
shall be made, however, in respect of any amount which was deducted for 
any previous taxable year or which is deducted for the taxable year in 
which such amount is paid.
    (2) Time for making election. The election under subparagraph (1) of 
this paragraph shall be made not later than the time, including 
extensions thereof, prescribed by law for filing the income tax return 
for the succeeding taxable year. Such election shall, except as provided 
in subparagraph (4) of this paragraph, become irrevocable after the last 
day prescribed for making it. Having made the election for any taxable 
year, the fiduciary may, within the time prescribed for making it, 
revoke the election without the consent of the Commissioner.
    (3) Manner of making the election. The election shall be made by 
filing with the income tax return (or an amended return) for the taxable 
year in which the contribution is treated as paid a statement which:
    (i) States the name and address of the fiduciary,
    (ii) Identifies the estate or trust for which the fiduciary is 
acting,
    (iii) Indicates that the fiduciary is making an election under 
section 642(c)(1) in respect of contributions treated as paid during 
such taxable year,
    (iv) Gives the name and address of each organization to which any 
such contribution is paid, and
    (v) States the amount of each contribution and date of actual 
payment or, if applicable, the total amount of contributions paid to 
each organization during the succeeding taxable year, to be treated as 
paid in the preceding taxable year.
    (4) Revocation of certain elections with consent. An application to 
revoke with the consent of the Commissioner any election made on or 
before June 8, 1970, must be in writing and must be filed not later than 
September 2, 1975.

No consent will be granted to revoke an election for any taxable year 
for which the assessment of a deficiency is prevented by the operation 
of any law or rule of law. If consent to revoke the election is granted, 
the fiduciary must attach a copy of the consent to the return (or 
amended return) for each taxable year affected by the revocation. The 
application must be addressed to the Commissioner of Internal Revenue, 
Washington, DC 20224, and must indicate:
    (i) The name and address of the fiduciary and the estate or trust 
for which he was acting,
    (ii) The taxable year for which the election was made,
    (iii) The office of the district director, or the service center, 
where the return (or amended return) for the year of election was filed, 
and
    (iv) The reason for revoking the election.

[T.D. 7357, 40 FR 23739, June 2, 1975; 40 FR 24361, June 6, 1975]



Sec. 1.642(c)-2   Unlimited deduction for amounts permanently set aside for a charitable purpose.

    (a) Estates. Any part of the gross income of an estate which 
pursuant to the terms of the will:
    (1) Is permanently set aside during the taxable year for a purpose 
specified in section 170(c), or

[[Page 19]]

    (2) Is to be used (within or without the United States or any of its 
possessions) exclusively for religious, charitable, scientific, 
literary, or educational purposes, or for the prevention of cruelty to 
children or animals, or for the establishment, acquisition, maintenance, 
or operation of a public cemetery not operated for profit,

shall be allowed as a deduction to the estate in lieu of the limited 
charitable contributions deduction authorized by section 170(a).
    (b) Certain trusts--(1) In general. Any part of the gross income of 
a trust to which either subparagraph (3) or (4) of this paragraph 
applies, that by the terms of the governing instrument:
    (i) Is permanently set aside during the taxable year for a purpose 
specified in section 170(c), or
    (ii) Is to be used (within or without the United States or any of 
its possessions) exclusively for religious, charitable, scientific, 
literary, or educational purposes, or for the prevention of cruelty to 
children or animals, or for the establishment, acquisition, maintenance, 
or operation of a public cemetery not operated for profit,

shall be allowed, subject to the limitation provided in subparagraph (2) 
of this paragraph, as a deduction to the trust in lieu of the limited 
charitable contributions deduction authorized by section 170(a). The 
preceding sentence applied only to a trust which is required by the 
terms of its governing instrument to set amounts aside. See section 
642(c)(6) and Sec. 1.642(c)-4 for disallowance of a deduction under this 
section to a trust which is, or is treated under section 4947(a)(1) as 
though it were, a private foundation (as defined in section 509(a) and 
the regulations thereunder) that is not exempt from taxation under 
section 501(a).
    (2) Limitation of deduction. Subparagraph (1) of this paragraph 
applies only to the gross income earned by a trust with respect to 
amounts transferred to the trust under a will executed on or before 
October 9, 1969, and satisfying the requirements of subparagraph (4) of 
this paragraph or transferred to the trust on or before October 9, 1969. 
For such purposes, any income, gains, or losses, which are derived at 
any time from the amounts so transferred to the trust shall also be 
taken into account in applying subparagraph (1) of this paragraph. If 
any such amount so transferred to the trust is invested or reinvested at 
any time, any asset received by the trust upon such investment or 
reinvestment shall also be treated as an amount which was so transferred 
to the trust. In the case of a trust to which this paragraph applies 
which contains (i) amounts transferred pursuant to transfers described 
in the first sentence of this subparagraph and (ii) amounts transferred 
pursuant to transfers not so described, subparagraph (1) of this 
paragraph shall apply only if the amounts described in subdivision (i) 
of this subparagraph, together with all income, gains, and losses 
derived therefrom, are separately accounted for from the amounts 
described in subdivision (ii) of this subparagraph, together with all 
income, gains, and losses derived therefrom. Such separate accounting 
shall be carried out consistently with the principles of paragraph 
(c)(4) of Sec. 53.4947-1 of this chapter (Foundation Excise Tax 
Regulations), relating to accounting for segregated amounts of split-
interest trusts.
    (3) Trusts created on or before October 9, 1969. A trust to which 
this subparagraph applies is a trust, testamentary or otherwise, which 
was created on or before October 9, 1969, and which qualifies under 
either subdivision (i) or (ii) of this subparagraph.
    (i) Transfer of irrevocable remainder interest to charity. To 
qualify under this subdivision the trust must have been created under 
the terms of an instrument granting an irrevocable remainder interest in 
such trust to or for the use of an organization described in section 
170(c). If the instrument granted a revocable remainder interest but the 
power to revoke such interest terminated on or before October 9, 1969, 
without the remainder interest having been revoked, the remainder 
interest will be treated as irrevocable for purposes of the preceding 
sentence.
    (ii) Grantor under a mental disability to change terms of trust. (A) 
To qualify under this subdivision (ii) the trust must have been created 
by a grantor who was at all times after October 9, 1969, under a mental 
disability to

[[Page 20]]

change the terms of the trust. The term mental disability for this 
purpose means mental incompetence to change the terms of the trust, 
whether or not there has been an adjudication of mental incompetence and 
whether or not there has been an appointment of a committee, guardian, 
fiduciary, or other person charged with the care of the person or 
property of the grantor.
    (B) If the grantor has not been adjudged mentally incompetent, the 
trustee must obtain from a qualified physician a certificate stating 
that the grantor of the trust has been mentally incompetent at all times 
after October 9, 1969, and that there is no reasonable probability that 
the grantor's mental capacity will ever improve to the extent that he 
will be mentally competent to change the terms of the trust. A copy of 
this certification must be filed with the first return on which a 
deduction is claimed by reason of this subdivision (ii) and subparagraph 
(1) of this paragraph. Thereafter, a statement referring to such medical 
opinion must be attached to any return for a taxable year for which such 
a deduction is claimed and during which the grantor's mental 
incompetence continues. The original certificate must be retained by the 
trustee of the trust.
    (C) If the grantor has been adjudged mentally incompetent, a copy of 
the judgment or decree, and any modification thereof, must be filed with 
the first return on which a deduction is claimed by reason of this 
subdivision (ii) and subparagraph (1) of this paragraph. Thereafter, a 
statement referring to such judgment or decree must be attached to any 
return for a taxable year for which such a deduction is claimed and 
during which the grantor's mental incompetence continues. A copy of such 
judgment or decree must also be retained by the trustee of the trust.
    (D) This subdivision (ii) applies even though a person charged with 
the care of the person or property of the grantor has the power to 
change the terms of the trust.
    (4) Testamentary trust established by will executed on or before 
October 9, 1969. A trust to which this subparagraph applies is a trust 
which was established by will executed on or before October 9, 1969, and 
which qualifies under either subdivision (i), (ii), or (iii) of this 
subparagraph. This subparagraph does not apply, however, to that portion 
of any trust, not established by a will executed on or before October 9, 
1969, which was transferred to such trust by a will executed on or 
before October 9, 1969. Nor does it apply to that portion of any trust, 
not established by a will executed on or before October 9, 1969, which 
was subject to a testamentary power of appointment that fails by reason 
of the testator's nonexercise of the power in a will executed on or 
before October 9, 1969.
    (i) Testator dying within 3 years without republishing his will. To 
qualify under this subdivision the trust must have been established by 
the will of a testator who died after October 9, 1969, but before 
October 9, 1972, without having amended any dispositive provision of the 
will after October 9, 1969, by codicil or otherwise.
    (ii) Testator having no right to change his will. To qualify under 
this subdivision the trust must have been established by the will of a 
testator who died after October 9, 1969, and who at no time after that 
date had the right to change any portion of such will pertaining to such 
trust. This subdivision could apply, for example, where a contract has 
been entered into for the execution of wills containing reciprocal 
provisions as well as provisions for the benefit of an organization 
described in section 170(c) and under applicable local law the surviving 
testator is prohibited from revoking his will because he has accepted 
the benefit of the provisions of the will of the other contracting 
party.
    (iii) Testator under a mental disability to republish his will. To 
qualify under this subdivision the trust must have been established by 
the will of a testator who died after October 8, 1972, without having 
amended any dispositive provision of such will after October 9, 1969, 
and before October 9, 1972, by codicil or otherwise, and who is under a 
mental disability at all times after October 8, 1972, to amend such 
will, by codicil or otherwise. The provisions of subparagraph (3)(ii) of 
this

[[Page 21]]

paragraph with respect to mental incompetence apply for purposes of this 
subdivision.
    (iv) Amendment of dispositive provisions. The provisions of 
paragraph (e) (4) and (5) of Sec. 20.2055-2 of this chapter (Estate Tax 
Regulations) are to be applied under subdivisions (i) and (iii) of this 
subparagraph in determining whether there has been an amendment of a 
dispositive provision of a will.
    (c) Pooled income funds. Any part of the gross income of a pooled 
income fund to which Sec. 1.642(c)-5 applies for the taxable year that 
is attributable to net long-term capital gain (as defined in section 
1222(7)) which, pursuant to the terms of the governing instrument, is 
permanently set aside during the taxable year for a purpose specified in 
section 170(c) shall be allowed as a deduction to the fund in lieu of 
the limited charitable contributions deduction authorized by section 
170(a). No deduction shall be allowed under this paragraph for any 
portion of the gross income of such fund which is (1) attributable to 
income other than net long-term capital gain (2) earned with respect to 
amounts transferred to such fund before August 1, 1969. However, see 
paragraph (b) of this section for a deduction (subject to the 
limitations of such paragraph) for amounts permanently set aside by a 
pooled income fund which meets the requirements of that paragraph. The 
principles of paragraph (b) or (2) of this section with respect to 
investment, reinvestment, and separate accounting shall apply under this 
paragraph in the case of amounts transferred to the fund after July 31, 
1969.
    (d) Disallowance of deduction for certain amounts not deemed to be 
permanently set aside for charitable purposes. No amount will be 
considered to be permanently set aside, or to be used, for a purpose 
described in paragraph (a) or (b)(1) of this section unless under the 
terms of the governing instrument and the circumstances of the 
particular case the possibility that the amount set aside, or to be 
used, will not be devoted to such purpose or use is so remote as to be 
negligible. Thus, for example, where there is possibility of the 
invasion of the corpus of a charitable remainder trust, as defined in 
Sec. 1.664-1(a)(1)(ii), in order to make payment of the annuity amount 
or unitrust amount, no deduction will be allowed under paragraph (a) of 
this section in respect of any amount set aside by an estate for 
distribution to such a charitable remainder trust.

For treatment of distributions by an estate to a charitable remainder 
trust, see paragraph (a)(5)(iii) of Sec. 1.664-1.

[T.D. 7357, 40 FR 23740, June 2, 1975; 40 FR 24361, June 6, 1975]



Sec. 1.642(c)-3   Adjustments and other special rules for determining unlimited charitable contributions deduction.

    (a) Income in respect of a decedent. For purposes of Secs. 1.642(c)-
1 and 1.642(c)-2, an amount received by an estate or trust which is 
includible in its gross income under section 691(a)(1) as income in 
respect of a decedent shall be included in the gross income of the 
estate or trust.
    (b) Reduction of charitable contributions deduction by amounts not 
included in gross income. (1) If an estate, pooled income fund, or other 
trust pays, permanently sets aside, or uses any amount of its income for 
a purpose specified in section 642(c) (1), (2) or (3) and that amount 
includes any items of estate or trust income not entering into the gross 
income of the estate or trust, the deduction allowable under 
Sec. 1.642(c)-1 or Sec. 1.642(c)-2 is limited to the gross income so 
paid, permanently set aside, or used. In the case of a pooled income 
fund for which a deduction is allowable under paragraph (c) of 
Sec. 1.642(c)-2 for amounts permanently set aside, only the gross income 
of the fund which is attributable to net long-term capital gain (as 
defined in section 1222(7)) shall be taken into account.
    (2) In determining whether the amounts of income so paid, 
permanently set aside, or used for a purpose specified in section 642(c) 
(1), (2), or (3) include particular items of income of an estate or 
trust not included in gross income, the specific provision controls if 
the governing instrument specifically provides as to the source out of 
which amounts are to be paid, permanently set aside, or used for such a 
purpose.


[[Page 22]]


In the absence of specific provisions in the governing instrument, an 
amount to which section 642(c) (1), (2) or (3) applies is deemed to 
consist of the same proportion of each class of the items of income of 
the estate or trust as the total of each class bears to the total of all 
classes. See paragraph (b) of Sec. 1.643(a)-5 for the method of 
determining the allocable portion of exempt income and foreign income.
    (3) For examples showing the determination of the character of an 
amount deductible under Sec. 1.642(c)-1 or Sec. 1.642(c)-2, see examples 
1 and 2 in Sec. 1.662(b)-2 and paragraph (e) of the example in 
Sec. 1.662(c)-4.
    (4) For the purpose of this paragraph, the provisions of section 116 
are not to be taken into account.
    (c) Capital gains included in charitable contribution. Where any 
amount of the income paid, permanently set aside, or used for a purpose 
specified in section 642(c) (1), (2), or (3), is attributable to net 
long-term capital gain (as defined in section 1222(7)), the amount of 
the deduction otherwise allowable under Sec. 1.642(c)-1 or 
Sec. 1.642(c)-2, must be adjusted for any deduction provided in section 
1202 of 50 percent of the excess, if any, of the net long-term capital 
gain over the net short-term capital loss. For determination of the 
extent to which the contribution to which Sec. 1.642(c)-1 or 
Sec. 1.642(c)-2 applies is deemed to consist of net long-term capital 
gains, see paragraph (b) of this section. The application of this 
paragraph may be illustrated by the following examples:

    Example 1. Under the terms of the trust instrument, the income of a 
trust described in Sec. 1.642(c)-2 (b)(3)(i) is currently distributable 
to A during his life and capital gains are allocable to corpus. No 
provision is made in the trust instrument for the invasion of corpus for 
the benefit of A. Upon A's death the corpus of the trust is to be 
distributed to M University, an organization described in section 
501(c)(3) which is exempt from taxation under section 501(a). During the 
taxable year ending December 31, 1970, the trust has long-term capital 
gains of $100,000 from property transferred to it on or before October 
9, 1969, which are permanently set aside for charitable purposes. The 
trust includes $100,000 in gross income but is allowed a deduction of 
$50,000 under section 1202 for the long-term capital gains and a 
charitable contributions deduction of $50,000 under section 642(c)(2) 
($100,000 permanently set aside for charitable purposes less $50,000 
allowed as a deduction under section 1202 with respect to such 
$100,000).
    Example 2. Under the terms of the will, $200,000 of the income 
(including $100,000 capital gains) for the taxable year 1972 of an 
estate is distributed, one-quarter to each of two individual 
beneficiaries and one-half to N University, an organization described in 
section 501(c)(3) which is exempt from taxation under section 501(a). 
During 1972 the estate has ordinary income of $200,000, long-term 
capital gains of $100,000, and no capital losses. It is assumed that for 
1972 the estate has no other items of income or any deductions other 
than those discussed herein. The entire capital gains of $100,000 are 
included in the gross income of the estate for 1972, and N University 
receives $100,000 from the estate in such year. However, the amount 
allowable to the estate under section 642(c)(1) is subject to 
appropriate adjustment for the deduction allowable under section 1202. 
In view of the distributions of $25,000 of capital gains to each of the 
individual beneficiaries, the deduction allowable to the estate under 
section 1202 is limited by such section to $25,000 [($100,000 capital 
gains less $50,000 capital gains includible in income of individual 
beneficiaries under section 662)  x  50%]. Since the whole of this 
$25,000 deduction under section 1202 is attributable to the distribution 
of $50,000 of capital gains to N University, the deduction allowable to 
the estate in 1972 under section 642(c)(1) is $75,000 [$100,000 
(distributed to N) less $25,000 (proper adjustment for section 1202 
deduction)].
    Example 3. Under the terms of the trust instrument, 30 percent of 
the gross income (exclusive of capital gains) of a trust described in 
Sec. 1.642(c)-2(b)(3)(i) is currently distributed to B, the sole income 
beneficiary. Net capital gains (capital gain net income for taxable 
years beginning after December 31, 1976) and undistributed ordinary 
income are allocable to corpus. No provision is made in the trust 
instrument for the invasion of corpus for the benefit of B. Upon B's 
death the remainder of the trust is to be distributed to M Church. 
During the taxable year 1972, the trust has ordinary income of $100,000, 
long-term capital gains of $15,000, short-term capital gains of $1,000, 
long-term capital losses of $5,000, and short-term capital losses of 
$2,500. It is assumed that the trust has no other items of income or any 
deductions other than those discussed herein. All the ordinary income 
and capital gains and losses are attributable to amounts transferred to 
the trust before October 9, 1969. The trust includes in gross income for 
1972 the total amount of $116,000 [$100,000 (ordinary income)+$16,000 
(total capital gains determined without regard to capital losses)]. 
Pursuant to the terms of the governing instrument the trust distributes 
to B in 1972 the amount of

[[Page 23]]

$30,000 ($100,000 x 30%). The balance of $78,500 [($116,000 less $7,500 
capital losses) -030,000 distribution] is available for the set-aside 
for charitable purposes. In determining taxable income for 1972 the 
capital losses of $7,500 ($5,000+$2,500) are allowable in full under 
section 1211(b)(1). The net capital gain (capital gain net income for 
taxable years beginning after December 31, 1976) of $8,500 ($16,000 less 
$7,500) is the excess of the net long-term capital gain of $10,000 
($15,000 less $5,000) over the net short-term capital loss of $1,500 
($2,500 less $1,000). The deduction under section 1202 is $4,250 
($8,500 x 50%), all of which is attributable to the set-aside for 
charitable purposes. Accordingly, for 1972 the deduction allowable to 
the trust under section 642(c)(2) is $74,250 [$78,500 (set-aside for M) 
less $4,250 (proper adjustment for section 1202 deduction)].
    Example 4. During the taxable year a pooled income fund, as defined 
in Sec. 1.642(c)-5, has in addition to ordinary income long-term capital 
gains of $150,000, short-term capital gains of $15,000, long-term 
capital losses of $100,000, and short-term capital losses of $10,000. 
Under the Declaration of Trust and pursuant to State law net long-term 
capital gain is allocable to corpus and net short-term capital gain is 
to be distributed to the income beneficiaries of the fund. All the 
capital gains and losses are attributable to amounts transferred to the 
fund after July 31, 1969. In view of the distribution of the net short-
term capital gain of $5,000 ($15,000 less $10,000) to the income 
beneficiaries, the deduction allowed to the fund under section 1202 is 
limited by such section to $25,000 [($150,000 (long-term capital gains) 
less $100,000 (long-term capital losses)) x 50%]. Since the whole of 
this deduction under section 1202 is attributable to the set-aside for 
charitable purposes, the deduction of $50,000 ($150,000 less $100,000) 
otherwise allowable under section 642(c)(3) is subject to appropriate 
adjustment under section 642(c)(4) for the deduction allowable under 
section 1202. Accordingly, the amount of the set-aside deduction is 
$25,000 [$50,000 (set-aside for public charity) less $25,000 (proper 
adjustment for section 1202 deduction)].
    Example 5. The facts are the same as in example 4 except that under 
the Declaration of Trust and pursuant to State law all the net capital 
gain (capital gain net income for taxable years beginning after December 
31, 1976) for the taxable year is allocable to corpus of the fund. The 
fund would thus include in gross income total capital gains of $165,000 
($150,000+$15,000). In determining taxable income for the taxable year 
the capital losses of $110,000 ($100,000+$10,000) are allowable in full 
under section 1211(b)(1). The net capital gain of $55,000 ($165,000 less 
$110,000) is available for the set-aside for charitable purposes under 
section 642(c)(3) only in the amount of the net long-term capital gain 
of $50,000 ($150,000 long-term gains less $100,000 long-term losses). 
The deduction under section 1202 is $25,000 ($50,000 x 50%), all of 
which is attributable to the set-aside for charitable purposes. 
Accordingly, the deduction allowable to the fund under section 642(c)(3) 
is $25,000 [$50,000 (set-aside for public charity) less $25,000 (proper 
adjustment for section 1202 deduction)]. The $5,000 balance of net 
capital gain (capital gain net income for taxable years beginning after 
December 31, 1976) is taken into account in determining taxable income 
of the pooled income fund for the taxable year.

    (d) Disallowance of deduction for amounts allocable to unrelated 
business income. In the case of a trust, the deduction otherwise 
allowable under Sec. 1.642(c)-1 or Sec. 1.642(c)-2 is disallowed to the 
extent of amounts allocable to the trust's unrelated business income. 
See section 681(a) and the regulations thereunder.
    (e) Disallowance of deduction in certain cases. For disallowance of 
certain deductions otherwise allowable under section 642(c) (1), (2), or 
(3), see sections 508(d) and 4948(c)(4).
    (f) Information returns. For rules applicable to the annual 
information return that must be filed by trusts claiming a deduction 
under section 642(c) for the taxable year, see section 6034 and the 
regulations thereunder.

[T.D. 7357, 40 FR 23741, June 2, 1975; 40 FR 24361, June 6, 1975, as 
amended by T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.642(c)-4   Nonexempt private foundations.

    In the case of a trust which is, or is treated under section 
4947(a)(1) as though it were, a private foundation (as defined in 
section 509(a) and the regulations thereunder) that is not exempt from 
taxation under section 501(a) for the taxable year, a deduction for 
amounts paid or permanently set aside, or used for a purpose specified 
in section 642(c) (1), or (2) shall not be allowed under Sec. 1.642(c)-1 
or Sec. 1.642(c)-2, but such trust shall, subject to the provisions 
applicable to individuals, be allowed a deduction under section 170 for 
charitable contributions paid during the taxable year. Section 642(c)(6) 
and this section do not apply to a trust described in section 4947(a)(1) 
unless such trust fails to meet the requirements of section 508(e). 
However, if on October 9,

[[Page 24]]

1969, or at any time thereafter, a trust is recognized as being exempt 
from taxation under section 501(a) as an organization described in 
section 501(c)(3), if at such time such trust is a private foundation, 
and if at any time thereafter such trust is determined not to be exempt 
from taxation under section 501(a) as an organization described in 
section 501(c)(3), section 642(c)(6) and this section will apply to such 
trust. See Sec. 1.509 (b)-1 (b).

[T.D. 7357, 40 FR 23742, June 2, 1975; 40 FR 24362, June 6, 1975]



Sec. 1.642(c)-5   Definition of pooled income fund.

    (a) In general--(1) Application of provisions. Section 642(c)(5) 
prescribes certain rules for the valuation of contributions involving 
transfers to certain funds described in that section as pooled income 
funds. This section sets forth the requirements for qualifying as a 
pooled income fund and provides for the manner of allocating the income 
of the fund to the beneficiaries. Section 1.642(c)-6 provides for the 
valuation of a remainder interest in property transferred to a pooled 
income fund. Section 1.642(c)-7 provides transitional rules under which 
certain funds may be amended so as to qualify as pooled income funds in 
respect to transfers of property occurring after July 31, 1969.
    (2) Tax status of fund and its beneficiaries. Notwithstanding any 
other provision of this chapter, a fund which meets the requirements of 
a pooled income fund, as defined in section 642(c)(5) and paragraph (b) 
of this section, shall not be treated as an association within the 
meaning of section 7701(a)(3). Such a fund, which need not be a trust 
under local law, and its beneficiaries shall be taxable under part I, 
subchapter J, chapter 1 of the Code, but the provisions of subpart E 
(relating to grantors and others treated as substantial owners) of such 
part shall not apply to such fund.
    (3) Recognition of gain or loss on transfer to fund. No gain or loss 
shall be recognized to the donor on the transfer of property to a pooled 
income fund. In such case, the fund's basis and holding period with 
respect to property transferred to the fund by a donor shall be 
determined as provided in sections 1015(b) and 1223(2). If, however, a 
donor transfers property to a pooled income fund and, in addition to 
creating or retaining a life income interest therein, receives property 
from the fund, or transfers property to the fund which is subject to an 
indebtedness, this subparagraph shall not apply to the gain realized by 
reason of (i) the receipt of such property or (ii) the amount of such 
indebtedness, whether or not assumed by the pooled income fund, which is 
required to be treated as an amount realized on the transfer. For 
applicability of the bargain sale rules, see section 1011(b) and the 
regulations thereunder.
    (4) Charitable contributions deduction. A charitable contributions 
deduction for the value of the remainder interest, as determined under 
Sec. 1.642(c)-6, may be allowed under section 170, 2055, 2106, or 2522, 
where there is a transfer of property to a pooled income fund. For a 
special rule relating to the reduction of the amount of a charitable 
contribution of certain ordinary income property or capital gain 
property, see section 170(e)(1) (A) or (B)(i) and the regulations 
thereunder.
    (5) Definitions. For purposes of this section, Secs. 1.642(c)-6 and 
1.642(c)-7:
    (i) The term income has the same meaning as it does under section 
643(b) and the regulations thereunder.
    (ii) The term donor includes a decedent who makes a testamentary 
transfer of property to a pooled income fund.
    (iii) The term governing instrument means either the governing plan 
under which the pooled income fund is established and administered or 
the instrument of transfer, as the context requires.
    (iv) The term public charity means an organization described in 
clause (i) to (vi) of section 170(b)(1)(A). If an organization is 
described in clause (i) to (vi) of section 170(b)(1)(A) and is also 
described in clause (viii) of such section, it shall be treated as a 
public charity.
    (v) The term fair market value, when used with respect to property, 
means its value in excess of the indebtedness or charges against such 
property.
    (vi) The term determination date means each day within the taxable 
year of a pooled income fund on which

[[Page 25]]

a valuation is made of the property in the fund. The property in the 
fund shall be valued on the first day of the taxable year of the fund 
and on at least 3 other days within the taxable year. The period between 
any two consecutive determination dates within the taxable year shall 
not be greater than 3 calendar months. In the case of a taxable year of 
less than 12 months, the property in the fund shall be valued on the 
first day of such taxable year and on such other days within such year 
as occur at successive intervals of no greater than 3 calendar months. 
Where a valuation date falls on a Saturday, Sunday, or legal holiday (as 
defined in section 7503 and the regulations thereunder), the valuation 
may be made on either the next preceding day which is not a Saturday, 
Sunday, or legal holiday or the next succeeding day which is not a 
Saturday, Sunday, or legal holiday, so long as the next such preceding 
day or next such succeeding day is consistently used where the valuation 
date falls on a Saturday, Sunday, or legal holiday.
    (6) Cross references. (i) See section 4947(a)(2) and section 
4947(b)(3)(B) for the application to pooled income funds of the 
provisions relating to private foundations and section 508(e) for rules 
relating to provisions required in the governing instrument prohibiting 
certain activities specified in section 4947(a)(2).
    (ii) For rules for postponing the time for deduction of a charitable 
contribution of a future interest in tangible personal property, see 
section 170(a)(3) and the regulations thereunder.
    (b) Requirements for qualification as a pooled income fund. A pooled 
income fund to which this section applies must satisfy all of the 
following requirements:
    (1) Contribution of remainder interest to charity. Each donor must 
transfer property to the fund and contribute an irrevocable remainder 
interest in such property to or for the use of a public charity, 
retaining for himself, or creating for another beneficiary or 
beneficiaries, a life income interest in the transferred property. A 
contingent remainder interest shall not be treated as an irrevocable 
remainder interest for purposes of this subparagraph.
    (2) Creation of life income interest. Each donor must retain for 
himself for life an income interest in the property transferred to such 
fund, or create an income interest in such property for the life of one 
or more beneficiaries, each of whom must be living at the time of the 
transfer of the property to the fund by the donor. The term one or more 
beneficiaries includes those members of a named class who are alive and 
can be ascertained at the time of the transfer of the property to the 
fund. In the event more than one beneficiary of the income interest is 
designated, such beneficiaries may enjoy their shares of income 
concurrently, consecutively, or both concurrently and consecutively. The 
donor may retain the power exercisable only by will to revoke or 
terminate the income interest of any designated beneficiary other than 
the public charity. The governing instrument must specify at the time of 
the transfer the particular beneficiary or beneficiaries to whom the 
income is payable and the share of income distributable to each person 
so specified. The public charity to or for the use of which the 
remainder interest is contributed may also be designated as one of the 
beneficiaries of an income interest. The donor need not retain or create 
a life interest in all the income from the property transferred to the 
fund provided any income not payable under the terms of the governing 
instrument to an income beneficiary is contributed to, and within the 
taxable year in which it is received is paid to, the same public charity 
to or for the use of which the remainder interest is contributed. No 
charitable contributions deduction shall be allowed to the donor for the 
value of such income interest of the public charity or for the amount of 
any such income paid to such organization.
    (3) Commingling of property required. The property transferred to 
the fund by each donor must be commingled with, and invested or 
reinvested with, other property transferred to the fund by other donors 
satisfying the requirements of subparagraphs (1) and (2) of this 
paragraph. The governing instrument of the pooled income fund must 
contain a provision requiring compliance with the preceding sentence. 
The

[[Page 26]]

public charity to or for the use of which the remainder interest is 
contributed may maintain more than one pooled income fund, provided that 
each such fund is maintained by the organization and is not a device to 
permit a group of donors to create a fund which may be subject to their 
manipulation. The fund must not include property transferred under 
arrangements other than those specified in section 642(c)(5) and this 
paragraph. However, a fund shall not be disqualified as a pooled income 
fund under this paragraph because any portion of its properties is 
invested or reinvested jointly with other properties, not a part of the 
pooled income fund, which are held by, or for the use of, the public 
charity which maintains the fund, as for example, with securities in the 
general endowment fund of the public charity to or for the use of which 
the remainder interest is contributed. Where such joint investment or 
reinvestment of properties occurs, records must be maintained which 
sufficiently identify the portion of the total fund which is owned by 
the pooled income fund and the income earned by, and attributable to, 
such portion. Such a joint investment or reinvestment of properties 
shall not be treated as an association or partnership for purposes of 
the Code. A bank which serves as trustee of more than one pooled income 
fund may maintain a common trust fund to which section 584 applies for 
the collective investment and reinvestment of moneys of such funds.
    (4) Prohibition against exempt securities. The property transferred 
to the fund by any donor must not include any securities, the income 
from which is exempt from tax under subtitle A of the Code, and the fund 
must not invest in such securities. The governing instrument of the fund 
must contain specific prohibitions against accepting or investing in 
such securities.
    (5) Maintenance by charitable organization required. The fund must 
be maintained by the same public charity to or for the use of which the 
irrevocable remainder interest is contributed. The requirement of 
maintenance will be satisfied where the public charity exercises control 
directly or indirectly over the fund. For example, this requirement of 
control shall ordinarily be met when the public charity has the power to 
remove the trustee or trustees of the fund and designate a new trustee 
or trustees. A national organization which carries out its purposes 
through local organizations, chapters, or auxiliary bodies with which it 
has an identity of aims and purposes may maintain a pooled income fund 
(otherwise satisfying the requirements of this paragraph) in which one 
or more local organizations, chapters, or auxiliary bodies which are 
public charities have been named as recipients of the remainder 
interests. For example, a national church body may maintain a pooled 
income fund where donors have transferred property to such fund and 
contributed an irrevocable remainder interest therein to or for the use 
of various local churches or educational institutions of such body. The 
fact that such local organizations or chapters have been separately 
incorporated from the national organization is immaterial.
    (6) Prohibition against donor or beneficiary serving as trustee. The 
fund must not have, and the governing instrument must prohibit the fund 
from having, as a trustee a donor to the fund or a beneficiary (other 
than the public charity to or for the use of which the remainder 
interest is contributed) of an income interest in any property 
transferred to such fund. Thus, if a donor or beneficiary (other than 
such public charity) directly or indirectly has general responsibilities 
with respect to the fund which are ordinarily exercised by a trustee, 
such fund does not meet the requirements of section 642(c)(5) and this 
paragraph. The fact that a donor of property to the fund, or a 
beneficiary of the fund, is a trustee, officer, director, or other 
official of the public charity to or for the use of which the remainder 
interest is contributed ordinarily will not prevent the fund from 
meeting the requirements of section 642(c)(5) and this paragraph.
    (7) Income of beneficiary to be based on rate of return of fund. 
Each beneficiary entitled to income of any taxable year of the fund must 
receive such income in an amount determined by the rate of

[[Page 27]]

return earned by the fund for such taxable year with respect to his 
income interest, computed as provided in paragraph (c) of this section. 
The governing instrument of the fund shall direct the trustee to 
distribute income currently or within the first 65 days following the 
close of the taxable year in which the income is earned. Any such 
payment made after the close of the taxable year shall be treated as 
paid on the last day of the taxable year. A statement shall be attached 
to the return of the pooled income fund indicating the date and amount 
of such payments after the close of the taxable year. Subject to the 
provisions of part I, subchapter J, chapter 1 of the Code, the 
beneficiary shall include in his gross income all amounts properly paid, 
credited, or required to be distributed to the beneficiary during the 
taxable year or years of the fund ending within or with his taxable 
year. The governing instrument shall provide that the income interest of 
any designated beneficiary shall either terminate with the last regular 
payment which was made before the death of the beneficiary or be 
prorated to the date of his death.
    (8) Termination of life income interest. Upon the termination of the 
income interest retained or created by any donor, the trustee shall 
sever from the fund an amount equal to the value of the remainder 
interest in the property upon which the income interest is based. The 
value of the remainder interest for such purpose may be either (i) its 
value as of the determination date next succeeding the termination of 
the income interest or (ii) its value as of the date on which the last 
regular payment was made before the death of the beneficiary if the 
income interest is terminated on such payment date. The amount so 
severed from the fund must either be paid to, or retained for the use 
of, the designated public charity, as provided in the governing 
instrument. However, see subparagraph (3) of this paragraph for rules 
relating to commingling of property.
    (c) Allocation of income to beneficiary--(1) In general. Every 
income interest retained or created in property transferred to a pooled 
income fund shall be assigned a proportionate share of the annual income 
earned by the fund, such share, or unit of participation, being based on 
the fair market value of such property on the date of transfer, as 
provided in this paragraph.
    (2) Units of participation--(i) Unit plan. (a) On each transfer of 
property by a donor to a pooled income fund, one or more units of 
participation in the fund shall be assigned to the beneficiary or 
beneficiaries of the income interest retained or created in such 
property, the number of units of participation being equal to the number 
obtained by dividing the fair market value of the property by the fair 
market value of a unit in the fund at the time of the transfer.
    (b) The fair market value of a unit in the fund at the time of the 
transfer shall be determined by dividing the fair market value of all 
property in the fund at such time by the number of units then in the 
fund. The initial fair market value of a unit in a pooled income fund 
shall be the fair market value of the property transferred to the fund 
divided by the number of units assigned to the income interest in that 
property. The value of each unit of participation will fluctuate with 
each new transfer of property to the fund in relation to the 
appreciation or depreciation in the fair market value of the property in 
the fund, but all units in the fund will always have equal value.
    (c) The share of income allocated to to each unit of participation 
shall be determined by dividing the income of the fund for the taxable 
year by the outstanding number of units in the fund at the end of such 
year, except that, consistently with paragraph (b)(7) of this section, 
income shall be allocated to units outstanding during only part of such 
year by taking into consideration the period of time such units are 
outstanding. For this purpose the actual income of such part of the 
taxable year, or a prorated portion of the annual income, may be used, 
after making such adjustments as are reasonably necessary to reflect 
fluctuations during the year in the fair market value of the property in 
the fund.
    (ii) Other plans. The governing instrument of the fund may provide 
any other reasonable method not described in subdivision (i) of this 
subparagraph for assigning units of participation in the fund and 
allocating income to such

[[Page 28]]

units which reaches a result reasonably consistent with the provisions 
of such subdivision.
    (iii) Transfers between determination dates. For purposes of 
subdivisions (i) and (ii) of this subparagraph, if a transfer of 
property to the fund by a donor occurs on other than a determination 
date, the number of units of participation assigned to the income 
interest in such property may be determined by using the fair market 
value of the property in the fund on the determination date immediately 
preceding the date of transfer (determined without regard to the 
property so transferred), subject, however, to appropriate adjustments 
on the next succeeding determination date. Such adjustments may be made 
by any reasonable method, including the use of a method whereby the fair 
market value of the property in the fund at the time of the transfer is 
deemed to be the average of the fair market values of the property in 
the fund on the determination dates immediately preceding and succeeding 
the date of transfer. For purposes of determining such average any 
property transferred to the fund between such preceding and succeeding 
dates, or on such succeeding date, shall be excluded. The application of 
this subdivision may be illustrated by the following example:

    Example. The determination dates of a pooled income fund are the 
first day of each calendar month. On April 1, 1971, the fair market 
value of the property in the fund is $100,000, at which time 1,000 units 
of participation are outstanding with a value of $100 each. On April 15, 
1971, B transfers property with a fair market value of $50,000 to the 
fund, retaining for himself for life an income interest in such 
property. No other property is transferred to the fund after April 1, 
1971. On May 1, 1971, the fair market value of the property in the fund, 
including the property transferred by B, is $160,000. The average of the 
fair market values of the property in the fund (excluding the property 
transferred by B) on April 1 and May 1, 1971, is $105,000 ($100,000+ 
[$160,000-$50,000]2). Accordingly, the fair market value of a 
unit of participation in the fund on April 15, 1971, at the time of B's 
transfer may be deemed to be $105 ($105,000/1,000 units), and B is 
assigned 476.19 units of participation in the fund ($50,000/$105).

    (3) Special rule for partial allocation of income to charity. 
Notwithstanding subparagraph (2) of this paragraph, the governing 
instrument may provide that a unit of participation is entitled to share 
in the income of the fund in a lesser amount than would otherwise be 
determined under such subparagraph, provided that the income otherwise 
allocable to the unit under such subparagraph is paid within the taxable 
year in which it is received to the public charity to or for the use of 
which the remainder interest is contributed under the governing 
instrument.
    (4) Illustrations. The application of this paragraph may be 
illustrated by the following examples:

    Example 1. On July 1, 1970, A and B transfer separate properties 
with a fair market value of $20,000 and $10,000, respectively, to a 
newly created pooled income fund which is maintained by Y University and 
uses as its taxable year the fiscal year ending June 30. A and B each 
retain in themselves for life an income interest in such property, the 
remainder interest being contributed to Y University. The pooled income 
fund assigns an initial value of $100 to each unit of participation in 
the fund, and under the governing instruments A receives 200 units, and 
B receives 100 units, in the fund. On October 1, 1970, which is a 
determination date, C transfers property to the fund with a fair market 
value of $12,000, retaining in himself for life an income interest in 
such property and contributing the remainder interest to Y University. 
The fair market value of the property in the fund at the time of C's 
transfer is $36,000. The fair market value of A's and B's units at the 
time of such transfer is $120 each ($36,000/300). By reason of his 
transfer of property C is assigned 100 units of participation in the 
fund ($12,000/$120).
    Example 2. Assume that the pooled income fund in example 1 earns 
$2,600 for its taxable year ending June 30, 1971, and there are no 
further contributions of property to the fund in such year. Further 
assume $300 is earned in the first quarter ending September 30, 1970. 
Therefore, the fund earns $1 per unit for the first quarter ($300 
divided by 300 units outstanding) and $5.75 per unit for the remainder 
of the taxable year ( [$2,600-$300] divided by 400 units outstanding). 
If the fund distributes its income for the year based on its actual 
earnings per quarter, the income must be distributed as follows:

                                                                        
               Beneficiary                        Share of income       
                                                                        
A........................................  $1,350 ( [200 x $1]+[200 x   
                                            $5.75] ).                   
B........................................  $675 ( [100 x $1]+[100 x     
                                            $5.75] ).                   
C........................................  $575 (100 x $5.75).          
                                                                        

    Example 3. (a) On July 1, 1970, A and B transfer separate properties 
with a fair market value of $10,000 and $20,000, respectively,

[[Page 29]]

to a newly created pooled income fund which is maintained by X 
University and uses as its taxable year the fiscal year ending June 30. 
A and B each retain in themselves an income interest for life in such 
property, the remainder interest being contributed to X University. The 
governing instrument provides that each unit of participation in the 
fund shall have a value of not more than its initial fair market value; 
the instrument also provides that the income allocable to appreciation 
in the fair market value of such unit (to the extent in excess of its 
initial fair market value) at the end of each quarter of the fiscal year 
is to be distributed currently to X University. On October 1, 1970, 
which is a determination date, C contributes to the fund property with a 
fair market value of $60,000 and retains in himself an income interest 
for life in such property, the remainder interest being contributed to X 
University. The initial fair market value of the units assigned to A, B, 
and C is $100. A, B, and C's units of participation are as follows:

                                                                        
               Beneficiary                     Units of participation   
                                                                        
A........................................  100 ($10,000 divided by      
                                            $100).                      
B........................................  200 ($20,000 divided by      
                                            $100).                      
C........................................  100 ($10,000 divided by      
                                            $100).                      
                                                                        

    (b) The fair market value of the property in the fund at the time of 
C's contribution is $40,000. Assuming the fair market value of the 
property in the fund is $100,000 on December 31, 1970, and that the 
income of the fund for the second quarter ending December 31, 1970, is 
$2,000, the income is shared by the income beneficiaries and X 
University as follows:

                                                                        
               Beneficiary                      Allocation of income    
                                                                        
A, B, and C..............................  90% ($90,000 divided by      
                                            $100,000).                  
X University.............................  10% ($10,000 divided by      
                                            $100,000).                  
                                                                        

    (c) For the quarter ending December 31, 1970, each unit of 
participation is allocated $2 (90 percent x $2,000 divided by 900) of 
the income earned for that quarter. A, B, C, and X University share in 
the income as follows:

                                                                        
               Beneficiary                        Share of income       
                                                                        
A........................................  $200 (100 x $2).             
B........................................  $400 (200 x $2).             
C........................................  $1,200 (600 x $2).           
X University.............................  $200 (10% x $2,000).         
                                                                        

[T.D. 7105, 36 FR 6477, Apr. 6, 1971; 36 FR 7004, Apr. 13, 1971, as 
amended by T.D. 7125, 36 FR 11032, June 8, 1971; T.D. 7357, 40 FR 23742, 
June 2, 1975; T.D. 7633, 44 FR 57925, Oct. 9, 1979]



Sec. 1.642(c)-6  Valuation of a remainder interest in property transferred to a pooled income fund after April 30, 1989.

    (a) In general. (1) For purposes of sections 170, 2055, 2106, and 
2522, the fair market value of a remainder interest in property 
transferred to a pooled income fund is its present value determined 
under paragraph (d) of this section.
    (2) The present value of a remainder interest at the time of the 
transfer of property to the pooled income fund is determined by 
computing the present value (at the time of the transfer) of the life 
income interest and subtracting that value from the fair market value of 
the transferred property on the valuation date. The fact that the income 
beneficiary may not receive the last income payment, as provided in 
paragraph (b)(7) of Sec. 1.642(c)-5, is not taken into account for 
purposes of determining the value of the life income interest. For 
purposes of this section, the valuation date is the date on which 
property is transferred to the fund by the donor except that, for 
purposes of section 2055 or 2106, it is the alternate valuation date, if 
elected, under the provisions and limitations set forth in section 2032 
and the regulations thereunder.
    (3) Any claim for a deduction on any return for the value of the 
remainder interest in property transferred to a pooled income fund must 
be supported by a statement attached to the return showing the 
computation of the present value of the interest.
    (b) Actuarial computations by the Internal Revenue Service. The 
regulations in this and in related sections provide tables of actuarial 
factors and examples that illustrate the use of the tables in 
determining the value of remainder interests in property. Section 
1.7520-1(c)(2) refers to government publications that provide additional 
tables of factors and examples of computations for more complex 
situations. If the computation requires the use of a factor that is not 
provided in this section,

[[Page 30]]

the Commissioner may supply the factor upon a request for a ruling. A 
request for a ruling must be accompanied by a recitation of the facts 
including the pooled income fund's highest yearly rate of return for the 
3 taxable years immediately preceding the date of transfer, the date of 
birth of each measuring life, and copies of the relevant documents. A 
request for a ruling must comply with the instructions for requesting a 
ruling published periodically in the Internal Revenue Bulletin (see 
Secs. 601.201 and 601.601(d)(2)(ii)(b) of this chapter) and include 
payment of the required user fee. If the Commissioner furnishes the 
factor, a copy of the letter supplying the factor should be attached to 
the tax return in which the deduction is claimed. If the Commissioner 
does not furnish the factor, the taxpayer must furnish a factor computed 
in accordance with the principles set forth in this section.
    (c) Computation of pooled income fund's yearly rate of return. (1) 
For purposes of determining the present value of the life income 
interest, the yearly rate of return earned by a pooled income fund for a 
taxable year is the percentage obtained by dividing the amount of income 
earned by the pooled income fund for the taxable year by an amount equal 
to--
    (i) The average fair market value of the property in such fund for 
that taxable year; less
    (ii) The corrective term adjustment.
    (2) The average fair market value of the property in a pooled income 
fund for a taxable year shall be the sum of the amounts of the fair 
market value of all property held by the pooled income fund on each 
determination date, as defined in paragraph (a)(5)(vi) of Sec. 1.642(c)-
5, of such taxable year divided by the number of determination dates in 
such taxable year. For such purposes the fair market value of property 
held by the fund shall be determined without including any income earned 
by the fund.
    (3)(i) The corrective term adjustment shall be the sum of the 
products obtained by multiplying each income payment made by the pooled 
income fund within its taxable year by the percentage set forth in 
column (2) of the following table opposite the period within such year, 
set forth in column (1), which includes the date on which that payment 
is made:

                                  Table                                 
                                                                        
                                                       (2) Percentage of
                  (1) Payment period                        payment     
                                                                        
Last week of 4th quarter.............................            0      
Balance of 4th quarter...............................           25      
Last week of 3d quarter..............................           25      
Balance of 3d quarter................................           50      
Last week of 2d quarter..............................           50      
Balance of 2d quarter................................           75      
Last week of 1st quarter.............................           75      
Balance of 1st quarter...............................          100      
                                                                        

    (ii) If the taxable year of the fund consists of less than 12 
months, the corrective term adjustment shall be the sum of the products 
obtained by multiplying each income payment made by the pooled income 
fund within such taxable year by the percentage obtained by subtracting 
from 1 a fraction the numerator of which is the number of days from the 
first day of such taxable year to the date of such income payment and 
the denominator of which is 365.
    (4) A pooled income fund's method of calculating its yearly rate of 
return must be supported by a full statement attached to the income tax 
return of the pooled income fund for each taxable year.
    (5) The application of this paragraph may be illustrated by the 
following examples:

    Example 1. (a) The pooled income fund maintained by W University has 
established determination dates on the first day of each calendar 
quarter. The pooled income fund is on a calendar-year basis. The pooled 
income fund earned $5,000 of income during 1971. The fair market value 
of its property (determined without including any income earned by the 
fund), and the income paid out, on the first day of each calendar 
quarter in 1971 are as follows:

------------------------------------------------------------------------
                                    Fair market value                   
               Date                    of property       Income payment 
------------------------------------------------------------------------
Jan. 1............................   $100,000             $1,200        
Apr. 1............................    105,000              1,200        
July 1............................     95,000              1,200        
Oct. 1............................    100,000              1,400        
                                   -------------------------------------
                                      400,000              5,000        
------------------------------------------------------------------------


[[Page 31]]

    (b) The average fair market value of the property in the fund for 
1971 is $100,000 ($400,000, divided by 4).
    (c) The corrective term adjustment for 1971 is $3,050, determined by 
applying the percentages obtained in column (2) of the table in 
subparagraph (3) of this paragraph:

                                                                        
                   Multiplication:                          Product     
                                                                        
  100% x $1,200......................................     $1,200        
  75% x $1,200.......................................        900        
  50% x $1,200.......................................        600        
  25% x $1,400.......................................        350        
                                                      ------------------
    Sum of products..................................      3,050        
                                                                        

    (d) The pooled income fund's yearly rate of return for 1971 is 5.157 
percent, determined as follows:

                  $5,000$100,000-$3,050=0.05157

    Example 2. (a) The pooled income fund maintained by X University has 
established determination dates on the first day of each calendar 
quarter. The pooled income fund is on a calendar-year basis. The pooled 
income fund earned $5,000 of income during 1971 and paid out $3,000 on 
December 15, 1971, and $2,000 on January 15, 1972, the last amount being 
treated under paragraph (b)(7) of Sec. 1.642(c)-5 as paid on December 
31, 1971. The fair market value of its property (determined without 
including any income earned by the fund) on the determination dates in 
1971 and the income paid out during 1971 are as follows:

------------------------------------------------------------------------
                                    Fair market value                   
               Date                    of property       Income payment 
------------------------------------------------------------------------
Jan. 1............................   $125,000          .................
Apr. 1............................    125,000          .................
July 1............................     75,000          .................
Oct. 1............................     75,000                           
Dec. 15...........................  .................     $3,000        
Dec. 31...........................  .................      2,000        
                                   -------------------------------------
                                      400,000              5,000        
------------------------------------------------------------------------

    (b) The average fair market value of the property in the fund for 
1971 is $100,000 ($400,000 divided by 4).
    (c) The corrective term adjustment for 1971 is $750, determined by 
applying the percentages obtained in column (2) of the table in 
subparagraph (3) of this paragraph:

                                                                        
                                                            Product     
                                                                        
Multiplication:                                                         
  0% x $2,000........................................                   
  25% x $3,000.......................................       $750        
                                                      ------------------
    Sum of products..................................        750        
                                                                        

    (d) The pooled income fund's yearly rate of return for 1971 is 5.038 
percent, determined as follows:

                   $5,000$100,000-$750=0.05038

    (d) Valuation. The present value of the remainder interest in 
property transferred to a pooled income fund after April 30, 1989, is 
determined under paragraph (e) of this section. The present value of the 
remainder interest in property transferred to a pooled income fund for 
which the valuation date is before May 1, 1989, is determined under the 
following sections:

------------------------------------------------------------------------
                Valuation dates                                         
-----------------------------------------------  Applicable  regulations
               After                   Before                           
------------------------------------------------------------------------
                                                                        
                                      01-01-52  1.642(c)-6A(a)          
12-31-51...........................   01-01-71  1.642(c)-6A(b)          
12-31-70...........................   12-01-83  1.642(c)-6A(c)          
11-30-83...........................   05-01-89  1.642(c)-6A(d)          
------------------------------------------------------------------------

    (e)  Present value of the remainder interest in the case of 
transfers to pooled income funds for which the valuation date is after 
April 30, 1989--(1) In general. In the case of transfers to pooled 
income funds for which the valuation date is after April 30, 1989, the 
present value of a remainder interest is determined under this section. 
See, however, Sec. 1.7520-3(b) (relating to exceptions to the use of 
prescribed tables under certain circumstances). The present value of a 
remainder interest that is dependent on the termination of the life of 
one individual is computed by the use of Table S in paragraph (e)(5) of 
this section. For purposes of the computations under this section, the 
age of an individual is the age at the individual's nearest birthday. If 
the valuation date of a transfer to a pooled income fund is after April 
30, 1989, and before June 10, 1994, a transferor can rely on Notice 89-
24, 1989-1 C.B. 660, or Notice 89-60, 1989-1 C.B. 700, in valuing the 
transferred interest. (See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (2) Present value of a remainder interest. The present value of a 
remainder interest in property transferred to a pooled income fund is 
computed on the basis of--
    (i) Life contingencies determined from the values of lx that are set 
forth in Table 80CNSMT in Sec. 20.2031-7(d)(6) of

[[Page 32]]

this chapter (Estate Tax Regulations); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. For purposes of this paragraph 
(e), the yearly rate of return of a pooled income fund is determined as 
provided in Sec. 1.642(c)-6(c) unless the highest rate of return is 
deemed to be the rate described in paragraph (e)(3) of this section for 
funds in existence less than 3 taxable years. For purposes of this 
paragraph (e)(2)(ii), the first taxable year of a pooled income fund is 
considered a taxable year even though the taxable year consists of less 
than 12 months. However, appropriate adjustments must be made to 
annualize the rate of return earned by the fund for that period. Where 
it appears from the facts and circumstances that the highest yearly rate 
of return of the fund for the 3 taxable years immediately preceding the 
taxable year in which the transfer of property is made has been 
purposely manipulated to be substantially less than the rate of return 
that would otherwise be reasonably anticipated with the purpose of 
obtaining an excessive charitable deduction, that rate of return may not 
be used. In that case, the highest yearly rate of return of the fund is 
determined by treating the fund as a pooled income fund that has been in 
existence for less than 3 preceding taxable years.
    (3) Pooled income funds in existence less than 3 taxable years. If a 
pooled income fund has been in existence less than 3 taxable years 
immediately preceding the taxable year in which the transfer is made to 
the fund and the transfer to the fund is made after April 30, 1989, the 
highest rate of return is deemed to be the interest rate (rounded to the 
nearest two-tenths of one percent) that is 1 percent less than the 
highest annual average of the monthly section 7520 rates for the 3 
calendar years immediately preceding the calendar year in which the 
transfer to the pooled income fund is made. The deemed rate of return 
for transfers to new pooled income funds is recomputed each calendar 
year using the monthly section 7520 rates for the 3-year period 
immediately preceding the calendar year in which each transfer to the 
fund is made until the fund has been in existence for 3 taxable years 
and can compute its highest rate of return for the 3 taxable years 
immediately preceding the taxable year in which the transfer of property 
to the fund is made in accordance with the rules set forth in the first 
sentence of paragraph (e)(2)(ii) of this section.
    (4) Computation of value of remainder interest. The factor that is 
used in determining the present value of a remainder interest that is 
dependent on the termination of the life of one individual is the factor 
from Table S in paragraph (e)(5) of this section under the appropriate 
yearly rate of return opposite the number that corresponds to the age of 
the individual upon whose life the value of the remainder interest is 
based. The tables in paragraph (e)(5) of this section include factors 
for yearly rates of return from 4.2 to 14 percent. Many actuarial 
factors not contained in the tables in paragraph (e)(5) of this section 
are contained in Table S in Internal Revenue Service Publication 1457, 
``Actuarial Values, Alpha Volume,'' (8-89). A copy of this publication 
may be purchased from the Superintendent of Documents, United States 
Government Printing Office, Washington, DC 20402. For other situations, 
see Sec. 1.642(c)-6(b). If the yearly rate of return is a percentage 
that is between the yearly rates of return for which factors are 
provided, a linear interpolation must be made. The present value of the 
remainder interest is determined by multiplying the fair market value of 
the property on the valuation date by the appropriate remainder factor. 
This paragraph may be illustrated by the following example:

    Example. A, who will be 55 years old on May 8, 1990, transfers 
$100,000 to a pooled income fund on January 1, 1990, and retains a life 
income interest in the property. The highest yearly rate of return 
earned by the fund for its 3 preceding taxable years is 9.47 percent. In 
Table S, the remainder factor opposite 55 years under 9.4 percent is 
.18785 and under 9.6 percent is .18322. The present value of the 
remainder interest is $18,623.00, computed as follows:

[[Page 33]]



Factor at 9.4 percent for age 55...........................       .18785
Factor at 9.6 percent for age 55...........................       .18322
                                                            ------------
Difference.................................................       .00463
                                                                        

                                                             [GRAPHIC] [TIFF OMITTED] TR10JN94.002
                                                             

Factor at 9.4 percent for age 55...........................       .18785
Less: Interpolation adjustment.............................       .00162
                                                            ------------
Interpolated factor........................................       .18623
Present value of remainder interest:                                    
  ($100,000 x .18623)......................................   $18,623.00
                                                                        

    (5) Actuarial tables. In the case of transfers for which the 
valuation date is after April 30, 1989, the present value of a remainder 
interest dependent on the termination of one life in the case of a 
transfer to a pooled income fund is determined by use of the following 
tables:

[[Page 34]]



                                           Table S.--Based on Life Table 80CNSMT Single Life Remainder Factors                                          
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate                                          
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .07389    .06749    .06188    .05695    .05261    .04879    .04541    .04243    .03978    .03744
1...................................................    .06494    .05832    .05250    .04738    .04287    .03889    .03537    .03226    .02950    .02705
2...................................................    .06678    .05999    .05401    .04874    .04410    .03999    .03636    .03314    .03028    .02773
3...................................................    .06897    .06200    .05587    .05045    .04567    .04143    .03768    .03435    .03139    .02875
4...................................................    .07139    .06425    .05796    .05239    .04746    .04310    .03922    .03578    .03271    .02998
5...................................................    .07401    .06669    .06023    .05451    .04944    .04494    .04094    .03738    .03421    .03137
6...................................................    .07677    .06928    .06265    .05677    .05156    .04692    .04279    .03911    .03583    .03289
7...................................................    .07968    .07201    .06521    .05918    .05381    .04903    .04477    .04097    .03757    .03453
8...................................................    .08274    .07489    .06792    .06172    .05621    .05129    .04689    .04297    .03945    .03630
9...................................................    .08597    .07794    .07079    .06443    .05876    .05370    .04917    .04511    .04148    .03821
10..................................................    .08936    .08115    .07383    .06730    .06147    .05626    .05159    .04741    .04365    .04027
11..................................................    .09293    .08453    .07704    .07035    .06436    .05900    .05419    .04988    .04599    .04250
12..................................................    .09666    .08807    .08040    .07354    .06739    .06188    .05693    .05248    .04847    .04486
13..................................................    .10049    .09172    .08387    .07684    .07053    .06487    .05977    .05518    .05104    .04731
14..................................................    .10437    .09541    .08738    .08017    .07370    .06788    .06263    .05791    .05364    .04978
15..................................................    .10827    .09912    .09090    .08352    .07688    .07090    .06551    .06064    .05623    .05225
16..................................................    .11220    .10285    .09445    .08689    .08008    .07394    .06839    .06337    .05883    .05472
17..................................................    .11615    .10661    .09802    .09028    .08330    .07699    .07129    .06612    .06144    .05719
18..................................................    .12017    .11043    .10165    .09373    .08656    .08009    .07422    .06890    .06408    .05969
19..................................................    .12428    .11434    .10537    .09726    .08992    .08327    .07724    .07177    .06679    .06226
20..................................................    .12850    .11836    .10919    .10089    .09337    .08654    .08035    .07471    .06959    .06492
21..................................................    .13282    .12248    .11311    .10462    .09692    .08991    .08355    .07775    .07247    .06765
22..................................................    .13728    .12673    .11717    .10848    .10059    .09341    .08686    .08090    .07546    .07049
23..................................................    .14188    .13113    .12136    .11248    .10440    .09703    .09032    .08418    .07858    .07345
24..................................................    .14667    .13572    .12575    .11667    .10839    .10084    .09395    .08764    .08187    .07659
25..................................................    .15167    .14051    .13034    .12106    .11259    .10486    .09778    .09130    .08536    .07991
26..................................................    .15690    .14554    .13517    .12569    .11703    .10910    .10184    .09518    .08907    .08346
27..................................................    .16237    .15081    .14024    .13056    .12171    .11359    .10614    .09930    .09302    .08724
28..................................................    .16808    .15632    .14555    .13567    .12662    .11831    .11068    .10366    .09720    .09125
29..................................................    .17404    .16208    .15110    .14104    .13179    .12329    .11547    .10827    .10163    .09551
30..................................................    .18025    .16808    .15692    .14665    .13721    .12852    .12051    .11313    .10631    .10002
31..................................................    .18672    .17436    .16300    .15255    .14291    .13403    .12584    .11827    .11127    .10480
32..................................................    .19344    .18090    .16935    .15870    .14888    .13980    .13142    .12367    .11650    .10985
33..................................................    .20044    .18772    .17598    .16514    .15513    .14587    .13730    .12936    .12201    .11519
34..................................................    .20770    .19480    .18287    .17185    .16165    .15221    .14345    .13533    .12780    .12080
35..................................................    .21522    .20215    .19005    .17884    .16846    .15883    .14989    .14159    .13388    .12670
36..................................................    .22299    .20974    .19747    .18609    .17552    .16571    .15660    .14812    .14022    .13287
37..................................................    .23101    .21760    .20516    .19360    .18286    .17288    .16358    .15492    .14685    .13933
38..................................................    .23928    .22572    .21311    .20139    .19048    .18032    .17085    .16201    .15377    .14607
39..................................................    .24780    .23409    .22133    .20945    .19837    .18804    .17840    .16939    .16097    .15310
40..................................................    .25658    .24273    .22982    .21778    .20654    .19605    .18624    .17706    .16847    .16043
41..................................................    .26560    .25163    .23858    .22639    .21499    .20434    .19436    .18502    .17627    .16806
42..................................................    .27486    .26076    .24758    .23525    .22370    .21289    .20276    .19326    .18434    .17597
43..................................................    .28435    .27013    .25683    .24436    .23268    .22172    .21143    .20177    .19270    .18416
44..................................................    .29407    .27975    .26633    .25373    .24191    .23081    .22038    .21057    .20134    .19265
45..................................................    .30402    .28961    .27608    .26337    .25142    .24019    .22962    .21966    .21028    .20144
46..................................................    .31420    .29970    .28608    .27326    .26120    .24983    .23913    .22904    .21951    .21053
47..................................................    .32460    .31004    .29632    .28341    .27123    .25975    .24892    .23870    .22904    .21991
48..................................................    .33521    .32058    .30679    .29379    .28151    .26992    .25897    .24862    .23883    .22957
49..................................................    .34599    .33132    .31746    .30438    .29201    .28032    .26926    .25879    .24888    .23949
50..................................................    .35695    .34224    .32833    .31518    .30273    .29094    .27978    .26921    .25918    .24966
51..................................................    .36809    .35335    .33940    .32619    .31367    .30180    .29055    .27987    .26973    .26010
52..................................................    .37944    .36468    .35070    .33744    .32486    .31292    .30158    .29081    .28057    .27083
53..................................................    .39098    .37622    .36222    .34892    .33629    .32429    .31288    .30203    .29170    .28186
54..................................................    .40269    .38794    .37393    .36062    .34795    .33590    .32442    .31349    .30308    .29316
55..................................................    .41457    .39985    .38585    .37252    .35983    .34774    .33621    .32522    .31474    .30473
56..................................................    .42662    .41194    .39796    .38464    .37193    .35981    .34824    .33720    .32666    .31658
57..................................................    .43884    .42422    .41028    .39697    .38426    .37213    .36053    .34945    .33885    .32872
58..................................................    .45123    .43668    .42279    .40951    .39682    .38468    .37307    .36196    .35132    .34114
59..................................................    .46377    .44931    .43547    .42224    .40958    .39745    .38584    .37471    .36405    .35383
60..................................................    .47643    .46206    .44830    .43513    .42250    .41040    .39880    .38767    .37699    .36674
61..................................................    .48916    .47491    .46124    .44814    .43556    .42350    .41192    .40080    .39012    .37985
62..................................................    .50196    .48783    .47427    .46124    .44874    .43672    .42518    .41408    .40340    .39314
63..................................................    .51480    .50081    .48736    .47444    .46201    .45006    .43856    .42749    .41684    .40658
64..................................................    .52770    .51386    .50054    .48773    .47540    .46352    .45208    .44105    .43043    .42019
65..................................................    .54069    .52701    .51384    .50115    .48892    .47713    .46577    .45480    .44422    .43401
66..................................................    .55378    .54029    .52727    .51472    .50262    .49093    .47965    .46876    .45824    .44808
67..................................................    .56697    .55368    .54084    .52845    .51648    .50491    .49373    .48293    .47248    .46238
68..................................................    .58026    .56717    .55453    .54231    .53049    .51905    .50800    .49729    .48694    .47691

[[Page 35]]

                                                                                                                                                        
69..................................................    .59358    .58072    .56828    .55624    .54459    .53330    .52238    .51179    .50154    .49160
70..................................................    .60689    .59427    .58205    .57021    .55874    .54762    .53683    .52638    .51624    .50641
71..................................................    .62014    .60778    .59578    .58415    .57287    .56193    .55131    .54100    .53099    .52126
72..................................................    .63334    .62123    .60948    .59808    .58700    .57624    .56579    .55563    .54577    .53617
73..................................................    .64648    .63465    .62315    .61198    .60112    .59056    .58029    .57030    .56059    .55113
74..................................................    .65961    .64806    .63682    .62590    .61527    .60492    .59485    .58504    .57550    .56620
75..................................................    .67274    .66149    .65054    .63987    .62948    .61936    .60950    .59990    .59053    .58140
76..................................................    .68589    .67495    .66429    .65390    .64377    .63390    .62427    .61487    .60570    .59676
77..................................................    .69903    .68841    .67806    .66796    .65811    .64849    .63910    .62993    .62097    .61223
78..................................................    .71209    .70182    .69179    .68199    .67242    .66307    .65393    .64501    .63628    .62775
79..................................................    .72500    .71507    .70537    .69588    .68660    .67754    .66867    .65999    .65151    .64321
80..................................................    .73768    .72809    .71872    .70955    .70058    .69180    .68320    .67479    .66655    .65849
81..................................................    .75001    .74077    .73173    .72288    .71422    .70573    .69741    .68926    .68128    .67345
82..................................................    .76195    .75306    .74435    .73582    .72746    .71926    .71123    .70335    .69562    .68804
83..................................................    .77346    .76491    .75654    .74832    .74026    .73236    .72460    .71699    .70952    .70219
84..................................................    .78456    .77636    .76831    .76041    .75265    .74503    .73756    .73021    .72300    .71592
85..................................................    .79530    .78743    .77971    .77212    .76466    .75733    .75014    .74306    .73611    .72928
86..................................................    .80560    .79806    .79065    .78337    .77621    .76917    .76225    .75544    .74875    .74216
87..................................................    .81535    .80813    .80103    .79404    .78717    .78041    .77375    .76720    .76076    .75442
88..................................................    .82462    .81771    .81090    .80420    .79760    .79111    .78472    .77842    .77223    .76612
89..................................................    .83356    .82694    .82043    .81401    .80769    .80147    .79533    .78929    .78334    .77747
90..................................................    .84225    .83593    .82971    .82357    .81753    .81157    .80570    .79991    .79420    .78857
91..................................................    .85058    .84455    .83861    .83276    .82698    .82129    .81567    .81013    .80466    .79927
92..................................................    .85838    .85263    .84696    .84137    .83585    .83040    .82503    .81973    .81449    .80933
93..................................................    .86557    .86009    .85467    .84932    .84405    .83884    .83370    .82862    .82360    .81865
94..................................................    .87212    .86687    .86169    .85657    .85152    .84653    .84160    .83673    .83192    .82717
95..................................................    .87801    .87298    .86801    .86310    .85825    .85345    .84872    .84404    .83941    .83484
96..................................................    .88322    .87838    .87360    .86888    .86420    .85959    .85502    .85051    .84605    .84165
97..................................................    .88795    .88328    .87867    .87411    .86961    .86515    .86074    .85639    .85208    .84782
98..................................................    .89220    .88769    .88323    .87883    .87447    .87016    .86589    .86167    .85750    .85337
99..................................................    .89612    .89176    .88745    .88318    .87895    .87478    .87064    .86656    .86251    .85850
100.................................................    .89977    .89555    .89136    .88722    .88313    .87908    .87506    .87109    .86716    .86327
101.................................................    .90326    .89917    .89511    .89110    .88712    .88318    .87929    .87543    .87161    .86783
102.................................................    .90690    .90294    .89901    .89513    .89128    .88746    .88369    .87995    .87624    .87257
103.................................................    .91076    .90694    .90315    .89940    .89569    .89200    .88835    .88474    .88116    .87760
104.................................................    .91504    .91138    .90775    .90415    .90058    .89704    .89354    .89006    .88661    .88319
105.................................................    .92027    .91681    .91337    .90996    .90658    .90322    .89989    .89659    .89331    .89006
106.................................................    .92763    .92445    .92130    .91816    .91506    .91197    .90890    .90586    .90284    .89983
107.................................................    .93799    .93523    .93249    .92977    .92707    .92438    .92170    .91905    .91641    .91378
108.................................................    .95429    .95223    .95018    .94814    .94611    .94409    .94208    .94008    .93809    .93611
109.................................................    .97985    .97893    .97801    .97710    .97619    .97529    .97438    .97348    .97259    .97170
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 36]]


                                           Table S.--Based on Life Table 80CNSMT Single Life Remainder Factors                                          
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate                                          
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        6.2%      6.4%      6.6%      6.8%      7.0%      7.2%      7.4%      7.6%      7.8%      8.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .03535    .03349    .03183    .03035    .02902    .02783    .02676    .02579    .02492    .02413
1...................................................    .02486    .02292    .02119    .01963    .01824    .01699    .01587    .01486    .01395    .01312
2...................................................    .02547    .02345    .02164    .02002    .01857    .01727    .01609    .01504    .01408    .01321
3...................................................    .02640    .02429    .02241    .02073    .01921    .01785    .01662    .01552    .01451    .01361
4...................................................    .02753    .02535    .02339    .02163    .02005    .01863    .01735    .01619    .01514    .01418
5...................................................    .02883    .02656    .02453    .02269    .02105    .01956    .01822    .01700    .01590    .01490
6...................................................    .03026    .02790    .02578    .02387    .02215    .02060    .01919    .01792    .01677    .01572
7...................................................    .03180    .02935    .02714    .02515    .02336    .02174    .02027    .01894    .01773    .01664
8...................................................    .03347    .03092    .02863    .02656    .02469    .02300    .02146    .02007    .01881    .01766
9...................................................    .03528    .03263    .03025    .02810    .02615    .02438    .02278    .02133    .02000    .01880
10..................................................    .03723    .03449    .03201    .02977    .02774    .02590    .02423    .02271    .02133    .02006
11..................................................    .03935    .03650    .03393    .03160    .02949    .02757    .02583    .02424    .02279    .02147
12..................................................    .04160    .03865    .03598    .03356    .03136    .02936    .02755    .02589    .02438    .02299
13..................................................    .04394    .04088    .03811    .03560    .03331    .03123    .02934    .02761    .02603    .02458
14..................................................    .04629    .04312    .04025    .03764    .03527    .03311    .03113    .02933    .02768    .02617
15..................................................    .04864    .04536    .04238    .03968    .03721    .03496    .03290    .03103    .02930    .02773
16..................................................    .05099    .04759    .04451    .04170    .03913    .03679    .03466    .03270    .03090    .02926
17..................................................    .05333    .04982    .04662    .04370    .04104    .03861    .03638    .03434    .03247    .03075
18..................................................    .05570    .05207    .04875    .04573    .04296    .04044    .03812    .03599    .03404    .03225
19..................................................    .05814    .05438    .05095    .04781    .04494    .04231    .03990    .03769    .03565    .03378
20..................................................    .06065    .05677    .05321    .04996    .04698    .04424    .04173    .03943    .03731    .03535
21..................................................    .06325    .05922    .05554    .05217    .04907    .04623    .04362    .04122    .03901    .03697
22..................................................    .06594    .06178    .05797    .05447    .05126    .04831    .04559    .04309    .04078    .03865
23..................................................    .06876    .06446    .06051    .05688    .05355    .05048    .04766    .04505    .04265    .04042
24..................................................    .07174    .06729    .06321    .05945    .05599    .05281    .04987    .04715    .04465    .04233
25..................................................    .07491    .07031    .06609    .06219    .05861    .05530    .05224    .04941    .04680    .04438
26..................................................    .07830    .07355    .06918    .06515    .06142    .05799    .05481    .05187    .04915    .04662
27..................................................    .08192    .07702    .07250    .06832    .06446    .06090    .05759    .05454    .05170    .04906
28..................................................    .08577    .08071    .07603    .07171    .06772    .06402    .06059    .05740    .05445    .05170
29..................................................    .08986    .08464    .07981    .07534    .07120    .06736    .06380    .06049    .05742    .05456
30..................................................    .09420    .08882    .08383    .07921    .07492    .07095    .06725    .06381    .06061    .05763
31..................................................    .09881    .09327    .08812    .08335    .07891    .07479    .07095    .06738    .06405    .06095
32..................................................    .10369    .09797    .09267    .08774    .08315    .07888    .07491    .07120    .06774    .06451
33..................................................    .10885    .10297    .09750    .09241    .08767    .08325    .07913    .07529    .07170    .06834
34..................................................    .11430    .10824    .10261    .09736    .09246    .08790    .08363    .07964    .07592    .07243
35..................................................    .12002    .11380    .10800    .10259    .09754    .09282    .08841    .08428    .08041    .07679
36..................................................    .12602    .11963    .11366    .10809    .10288    .09800    .09344    .08917    .08516    .08140
37..................................................    .13230    .12574    .11961    .11387    .10850    .10347    .09876    .09433    .09018    .08628
38..................................................    .13887    .13214    .12584    .11994    .11441    .10922    .10436    .09978    .09549    .09145
39..................................................    .14573    .13883    .13237    .12630    .12061    .11527    .11025    .10553    .10109    .09690
40..................................................    .15290    .14583    .13920    .13297    .12712    .12162    .11644    .11157    .10698    .10266
41..................................................    .16036    .15312    .14633    .13994    .13393    .12827    .12294    .11792    .11318    .10871
42..................................................    .16810    .16071    .15375    .14720    .14103    .13522    .12973    .12456    .11967    .11505
43..................................................    .17614    .16858    .16146    .15475    .14842    .14245    .13682    .13149    .12645    .12169
44..................................................    .18447    .17675    .16948    .16261    .15613    .15000    .14421    .13873    .13355    .12864
45..................................................    .19310    .18524    .17780    .17078    .16414    .15787    .15192    .14630    .14096    .13591
46..................................................    .20204    .19402    .18644    .17926    .17247    .16604    .15995    .15418    .14870    .14350
47..................................................    .21128    .20311    .19538    .18806    .18112    .17454    .16830    .16238    .15676    .15141
48..................................................    .22080    .21249    .20462    .19716    .19007    .18335    .17696    .17090    .16513    .15964
49..................................................    .23059    .22214    .21413    .20653    .19930    .19244    .18591    .17970    .17379    .16816
50..................................................    .24063    .23206    .22391    .21617    .20881    .20180    .19514    .18879    .18274    .17697
51..................................................    .25095    .24225    .23398    .22610    .21861    .21147    .20466    .19818    .19199    .18609
52..................................................    .26157    .25275    .24436    .23636    .22874    .22147    .21453    .20791    .20159    .19556
53..................................................    .27249    .26357    .25505    .24694    .23919    .23180    .22474    .21799    .21154    .20537
54..................................................    .28369    .27466    .26604    .25782    .24995    .24244    .23526    .22839    .22181    .21552
55..................................................    .29518    .28605    .27734    .26900    .26103    .25341    .24611    .23912    .23243    .22601
56..................................................    .30695    .29774    .28893    .28050    .27242    .26469    .25728    .25019    .24338    .23685
57..................................................    .31902    .30973    .30084    .29232    .28415    .27632    .26881    .26161    .25469    .24805
58..................................................    .33138    .32203    .31306    .30446    .29621    .28829    .28069    .27339    .26637    .25962
59..................................................    .34402    .33461    .32558    .31691    .30859    .30059    .29290    .28550    .27839    .27155
60..................................................    .35690    .34745    .33836    .32963    .32124    .31317    .30540    .29792    .29073    .28379
61..................................................    .36999    .36050    .35137    .34259    .33414    .32601    .31817    .31062    .30334    .29633
62..................................................    .38325    .37374    .36458    .35576    .34726    .33907    .33117    .32356    .31621    .30912
63..................................................    .39669    .38717    .37799    .36913    .36060    .35236    .34441    .33674    .32933    .32217
64..................................................    .41031    .40078    .39159    .38272    .37415    .36588    .35789    .35016    .34270    .33548
65..................................................    .42416    .41464    .40545    .39656    .38798    .37968    .37166    .36390    .35639    .34912
66..................................................    .43825    .42876    .41958    .41070    .40211    .39380    .38576    .37797    .37043    .36312
67..................................................    .45260    .44315    .43399    .42513    .41655    .40824    .40019    .39238    .38482    .37749
68..................................................    .46720    .45779    .44868    .43985    .43129    .42299    .41494    .40713    .39956    .39221

[[Page 37]]

                                                                                                                                                        
69..................................................    .48197    .47263    .46357    .45478    .44625    .43798    .42995    .42215    .41458    .40722
70..................................................    .49686    .48760    .47861    .46988    .46140    .45316    .44516    .43738    .42983    .42248
71..................................................    .51182    .50265    .49374    .48508    .47666    .46847    .46051    .45276    .44523    .43790
72..................................................    .52685    .51778    .50896    .50038    .49203    .48390    .47599    .46829    .46079    .45349
73..................................................    .54194    .53298    .52426    .51578    .50751    .49946    .49161    .48397    .47652    .46926
74..................................................    .55714    .54832    .53972    .53134    .52317    .51520    .50744    .49986    .49247    .48527
75..................................................    .57250    .56382    .55536    .54710    .53904    .53118    .52351    .51601    .50870    .50156
76..................................................    .58803    .57951    .57120    .56308    .55515    .54740    .53984    .53245    .52522    .51817
77..................................................    .60369    .59535    .58720    .57923    .57144    .56383    .55639    .54912    .54200    .53504
78..................................................    .61942    .61126    .60329    .59549    .58787    .58040    .57310    .56596    .55896    .55212
79..................................................    .63508    .62713    .61935    .61174    .60428    .59698    .58983    .58283    .57597    .56925
80..................................................    .65059    .64285    .63527    .62785    .62058    .61345    .60646    .59961    .59290    .58632
81..................................................    .66579    .65827    .65090    .64368    .63659    .62965    .62283    .61615    .60959    .60316
82..................................................    .68061    .67332    .66616    .65914    .65226    .64550    .63886    .63235    .62595    .61968
83..................................................    .69499    .68793    .68099    .67418    .66749    .66092    .65447    .64813    .64191    .63579
84..................................................    .70896    .70213    .69541    .68881    .68233    .67595    .66969    .66353    .65748    .65153
85..................................................    .72256    .71596    .70947    .70308    .69681    .69063    .68456    .67859    .67271    .66693
86..................................................    .73569    .72931    .72305    .71688    .71081    .70484    .69896    .69318    .68748    .68188
87..................................................    .74818    .74204    .73599    .73003    .72417    .71839    .71271    .70711    .70159    .69616
88..................................................    .76011    .75419    .74836    .74261    .73695    .73137    .72588    .72046    .71512    .70986
89..................................................    .77169    .76599    .76037    .75484    .74938    .74400    .73870    .73347    .72831    .72323
90..................................................    .78302    .77755    .77215    .76683    .76158    .75640    .75129    .74625    .74128    .73638
91..................................................    .79395    .78870    .78352    .77842    .77337    .76840    .76349    .75864    .75385    .74913
92..................................................    .80423    .79920    .79423    .78933    .78449    .77971    .77499    .77033    .76572    .76118
93..................................................    .81377    .80894    .80417    .79946    .79481    .79022    .78568    .78120    .77677    .77239
94..................................................    .82247    .81784    .81325    .80873    .80425    .79983    .79547    .79115    .78688    .78266
95..................................................    .83033    .82586    .82145    .81709    .81278    .80852    .80431    .80014    .79602    .79195
96..................................................    .83729    .83298    .82872    .82451    .82034    .81622    .81215    .80812    .80414    .80019
97..................................................    .84361    .83944    .83532    .83124    .82721    .82322    .81927    .81537    .81151    .80769
98..................................................    .84929    .84525    .84126    .83730    .83339    .82952    .82569    .82190    .81815    .81443
99..................................................    .85454    .85062    .84674    .84290    .83910    .83534    .83161    .82792    .82427    .82066
100.................................................    .85942    .85561    .85184    .84810    .84440    .84074    .83711    .83352    .82997    .82644
101.................................................    .86408    .86037    .85670    .85306    .84946    .84589    .84236    .83886    .83539    .83196
102.................................................    .86894    .86534    .86177    .85823    .85473    .85126    .84782    .84442    .84104    .83770
103.................................................    .87408    .87060    .86714    .86371    .86032    .85695    .85362    .85031    .84703    .84378
104.................................................    .87980    .87644    .87311    .86980    .86653    .86328    .86005    .85686    .85369    .85054
105.................................................    .88684    .88363    .88046    .87731    .87418    .87108    .86800    .86494    .86191    .85890
106.................................................    .89685    .89389    .89095    .88804    .88514    .88226    .87940    .87656    .87374    .87094
107.................................................    .91117    .90858    .90600    .90344    .90089    .89836    .89584    .89334    .89085    .88838
108.................................................    .93414    .93217    .93022    .92828    .92634    .92442    .92250    .92060    .91870    .91681
109.................................................    .97081    .96992    .96904    .96816    .96729    .96642    .96555    .96468    .96382    .96296
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 38]]


                                           Table S.--Based on Life Table 80CNSMT Single Life Remainder Factors                                          
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate                                          
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .02341    .02276    .02217    .02163    .02114    .02069    .02027    .01989    .01954    .01922
1...................................................    .01237    .01170    .01108    .01052    .01000    .00953    .00910    .00871    .00834    .00801
2...................................................    .01243    .01172    .01107    .01048    .00994    .00944    .00899    .00857    .00819    .00784
3...................................................    .01278    .01203    .01135    .01073    .01016    .00964    .00916    .00872    .00832    .00795
4...................................................    .01332    .01253    .01182    .01116    .01056    .01001    .00951    .00904    .00862    .00822
5...................................................    .01400    .01317    .01241    .01172    .01109    .01051    .00998    .00949    .00904    .00862
6...................................................    .01477    .01390    .01310    .01238    .01171    .01110    .01054    .01002    .00954    .00910
7...................................................    .01563    .01472    .01389    .01312    .01242    .01178    .01118    .01064    .01013    .00966
8...................................................    .01660    .01564    .01477    .01396    .01322    .01254    .01192    .01134    .01081    .01031
9...................................................    .01770    .01669    .01577    .01492    .01414    .01342    .01276    .01216    .01159    .01107
10..................................................    .01891    .01785    .01688    .01599    .01517    .01442    .01372    .01308    .01249    .01194
11..................................................    .02026    .01915    .01814    .01720    .01634    .01555    .01481    .01414    .01351    .01293
12..................................................    .02173    .02056    .01950    .01852    .01761    .01678    .01601    .01529    .01463    .01402
13..................................................    .02326    .02204    .02092    .01989    .01895    .01807    .01726    .01651    .01582    .01517
14..................................................    .02478    .02351    .02234    .02126    .02027    .01935    .01850    .01771    .01698    .01630
15..................................................    .02628    .02495    .02372    .02259    .02155    .02058    .01969    .01886    .01810    .01738
16..................................................    .02774    .02635    .02507    .02388    .02279    .02178    .02084    .01997    .01917    .01842
17..................................................    .02917    .02772    .02637    .02513    .02399    .02293    .02194    .02103    .02018    .01940
18..................................................    .03059    .02907    .02767    .02637    .02517    .02406    .02302    .02207    .02118    .02035
19..................................................    .03205    .03046    .02899    .02763    .02637    .02521    .02412    .02312    .02218    .02131
20..................................................    .03355    .03188    .03035    .02892    .02760    .02638    .02524    .02419    .02320    .02229
21..................................................    .03509    .03334    .03173    .03024    .02886    .02758    .02638    .02527    .02424    .02328
22..................................................    .03669    .03487    .03318    .03162    .03017    .02882    .02757    .02640    .02532    .02430
23..................................................    .03837    .03646    .03470    .03306    .03154    .03013    .02881    .02759    .02644    .02538
24..................................................    .04018    .03819    .03634    .03463    .03303    .03155    .03016    .02888    .02767    .02655
25..................................................    .04214    .04006    .03812    .03633    .03465    .03309    .03164    .03029    .02902    .02784
26..................................................    .04428    .04210    .04008    .03820    .03644    .03481    .03328    .03186    .03052    .02928
27..................................................    .04662    .04434    .04223    .04025    .03841    .03670    .03509    .03360    .03219    .03088
28..................................................    .04915    .04677    .04456    .04249    .04056    .03876    .03708    .03550    .03403    .03264
29..................................................    .05189    .04941    .04709    .04493    .04291    .04102    .03925    .03760    .03604    .03458
30..................................................    .05485    .05226    .04984    .04757    .04546    .04348    .04162    .03988    .03825    .03671
31..................................................    .05805    .05535    .05282    .05045    .04824    .04616    .04421    .04238    .04067    .03905
32..................................................    .06149    .05867    .05603    .05356    .05124    .04906    .04702    .04510    .04329    .04160
33..................................................    .06520    .06226    .05950    .05692    .05449    .05221    .05007    .04806    .04616    .04438
34..................................................    .06916    .06609    .06322    .06052    .05799    .05560    .05336    .05125    .04926    .04738
35..................................................    .07339    .07020    .06720    .06439    .06174    .05925    .05690    .05469    .05260    .05063
36..................................................    .07787    .07455    .07143    .06850    .06573    .06313    .06068    .05836    .05617    .05411
37..................................................    .08262    .07917    .07593    .07287    .06999    .06727    .06470    .06228    .05999    .05783
38..................................................    .08765    .08407    .08069    .07751    .07451    .07167    .06899    .06646    .06407    .06180
39..................................................    .09296    .08925    .08574    .08243    .07931    .07635    .07356    .07092    .06841    .06604
40..................................................    .09858    .09472    .09109    .08765    .08440    .08132    .07841    .07565    .07303    .07055
41..................................................    .10449    .10050    .09673    .09316    .08978    .08658    .08355    .08067    .07794    .07535
42..................................................    .11069    .10656    .10265    .09895    .09544    .09212    .08896    .08596    .08312    .08041
43..................................................    .11718    .11291    .10887    .10503    .10140    .09794    .09466    .09154    .08858    .08576
44..................................................    .12399    .11958    .11540    .11143    .10766    .10407    .10067    .09743    .09434    .09141
45..................................................    .13111    .12656    .12224    .11814    .11423    .11052    .10699    .10362    .10042    .09736
46..................................................    .13856    .13387    .12941    .12516    .12113    .11728    .11362    .11013    .10680    .10363
47..................................................    .14633    .14150    .13690    .13252    .12835    .12438    .12059    .11697    .11352    .11022
48..................................................    .15442    .14945    .14471    .14020    .13589    .13179    .12787    .12412    .12055    .11713
49..................................................    .16280    .15769    .15281    .14816    .14373    .13949    .13544    .13157    .12787    .12433
50..................................................    .17147    .16622    .16121    .15643    .15186    .14749    .14331    .13931    .13548    .13182
51..................................................    .18045    .17507    .16993    .16501    .16030    .15580    .15150    .14737    .14342    .13963
52..................................................    .18979    .18427    .17899    .17394    .16911    .16448    .16004    .15579    .15172    .14780
53..................................................    .19947    .19383    .18842    .18324    .17828    .17352    .16896    .16458    .16038    .15635
54..................................................    .20950    .20372    .19819    .19288    .18779    .18291    .17822    .17372    .16940    .16524
55..................................................    .21986    .21397    .20831    .20288    .19767    .19266    .18785    .18322    .17878    .17450
56..................................................    .23058    .22457    .21879    .21324    .20791    .20278    .19785    .19310    .18854    .18414
57..................................................    .24167    .23554    .22965    .22399    .21854    .21329    .20824    .20338    .19870    .19419
58..................................................    .25314    .24690    .24090    .23512    .22956    .22420    .21904    .21407    .20927    .20464
59..................................................    .26497    .25863    .25252    .24664    .24097    .23550    .23023    .22515    .22024    .21551
60..................................................    .27712    .27068    .26448    .25849    .25272    .24716    .24178    .23659    .23158    .22674
61..................................................    .28956    .28304    .27674    .27067    .26480    .25913    .25366    .24837    .24325    .23831
62..................................................    .30228    .29567    .28929    .28312    .27717    .27141    .26584    .26045    .25524    .25020
63..................................................    .31525    .30857    .30211    .29586    .28982    .28397    .27832    .27284    .26754    .26240
64..................................................    .32851    .32176    .31522    .30890    .30278    .29685    .29111    .28555    .28016    .27493
65..................................................    .34209    .33528    .32868    .32229    .31610    .31010    .30429    .29865    .29317    .28787
66..................................................    .35604    .34918    .34253    .33609    .32983    .32377    .31788    .31217    .30663    .30124
67..................................................    .37037    .36347    .35678    .35028    .34398    .33786    .33191    .32614    .32053    .31508
68..................................................    .38508    .37815    .37142    .36489    .35854    .35237    .34638    .34055    .33488    .32937

[[Page 39]]

                                                                                                                                                        
69..................................................    .40008    .39313    .38638    .37982    .37344    .36724    .36120    .35533    .34961    .34405
70..................................................    .41533    .40838    .40162    .39504    .38864    .38241    .37634    .37043    .36468    .35907
71..................................................    .43076    .42382    .41705    .41047    .40405    .39780    .39171    .38578    .38000    .37436
72..................................................    .44638    .43945    .43269    .42611    .41969    .41344    .40733    .40138    .39558    .38991
73..................................................    .46218    .45527    .44854    .44197    .43556    .42931    .42321    .41725    .41143    .40575
74..................................................    .47823    .47137    .46466    .45812    .45173    .44549    .43940    .43345    .42763    .42195
75..................................................    .49459    .48777    .48112    .47462    .46826    .46205    .45598    .45004    .44424    .43856
76..................................................    .51127    .50452    .49793    .49148    .48517    .47900    .47297    .46706    .46129    .45563
77..................................................    .52823    .52157    .51505    .50867    .50243    .49632    .49033    .48447    .47873    .47311
78..................................................    .54541    .53885    .53242    .52613    .51996    .51392    .50800    .50220    .49652    .49094
79..................................................    .56267    .55621    .54989    .54369    .53762    .53166    .52582    .52009    .51448    .50897
80..................................................    .57987    .57354    .56733    .56125    .55527    .54941    .54366    .53802    .53248    .52705
81..................................................    .59685    .59065    .58457    .57860    .57274    .56699    .56134    .55579    .55035    .54499
82..................................................    .61351    .60746    .60151    .59567    .58993    .58429    .57875    .57331    .56796    .56270
83..................................................    .62978    .62387    .61806    .61236    .60675    .60123    .59581    .59047    .58523    .58007
84..................................................    .64567    .63992    .63426    .62869    .62321    .61783    .61253    .60731    .60218    .59713
85..................................................    .66125    .65565    .65014    .64472    .63938    .63413    .62896    .62387    .61886    .61392
86..................................................    .67636    .67092    .66557    .66030    .65511    .65000    .64496    .64000    .63511    .63030
87..................................................    .69081    .68554    .68034    .67522    .67018    .66520    .66031    .65548    .65071    .64602
88..................................................    .70468    .69957    .69453    .68956    .68466    .67983    .67507    .67037    .66574    .66117
89..................................................    .71821    .71326    .70838    .70357    .69882    .69414    .68952    .68495    .68045    .67601
90..................................................    .73153    .72676    .72204    .71739    .71280    .70827    .70379    .69938    .69502    .69071
91..................................................    .74447    .73986    .73532    .73083    .72640    .72202    .71770    .71343    .70921    .70504
92..................................................    .75669    .75225    .74787    .74354    .73927    .73504    .73087    .72674    .72267    .71864
93..................................................    .76807    .76379    .75957    .75540    .75127    .74719    .74317    .73918    .73524    .73135
94..................................................    .77849    .77437    .77030    .76627    .76229    .75835    .75446    .75061    .74680    .74303
95..................................................    .78792    .78394    .78001    .77611    .77226    .76845    .76468    .76096    .75727    .75362
96..................................................    .79630    .79244    .78863    .78485    .78112    .77742    .77377    .77015    .76657    .76303
97..................................................    .80391    .80016    .79646    .79280    .78917    .78559    .78203    .77852    .77504    .77160
98..................................................    .81076    .80712    .80352    .79996    .79643    .79294    .78948    .78606    .78267    .77931
99..................................................    .81709    .81354    .81004    .80657    .80313    .79972    .79635    .79302    .78971    .78644
100.................................................    .82296    .81950    .81609    .81270    .80934    .80602    .80273    .79947    .79624    .79304
101.................................................    .82855    .82518    .82185    .81854    .81526    .81201    .80880    .80561    .80245    .79932
102.................................................    .83438    .83110    .82785    .82462    .82142    .81826    .81512    .81200    .80892    .80586
103.................................................    .84056    .83737    .83420    .83106    .82795    .82487    .82181    .81878    .81577    .81279
104.................................................    .84743    .84433    .84127    .83822    .83521    .83221    .82924    .82630    .82338    .82048
105.................................................    .85591    .85295    .85001    .84709    .84419    .84132    .83846    .83563    .83282    .83003
106.................................................    .86816    .86540    .86266    .85993    .85723    .85454    .85187    .84922    .84659    .84397
107.................................................    .88592    .88348    .88105    .87863    .87623    .87384    .87147    .86911    .86676    .86443
108.................................................    .91493    .91306    .91119    .90934    .90749    .90566    .90383    .90201    .90020    .89840
109.................................................    .96211    .96125    .96041    .95956    .95872    .95788    .95704    .95620    .95537    .95455
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 40]]


                                           Table S.--Based on Life Table 80CNSMT Single Life Remainder Factors                                          
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate                                          
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        10.2%     10.4%     10.6%     10.8%     11.0%     11.2%     11.4%     11.6%     11.8%     12.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01891    .01864    .01838    .01814    .01791    .01770    .01750    .01732    .01715    .01698
1...................................................    .00770    .00741    .00715    .00690    .00667    .00646    .00626    .00608    .00590    .00574
2...................................................    .00751    .00721    .00693    .00667    .00643    .00620    .00600    .00580    .00562    .00544
3...................................................    .00760    .00728    .00699    .00671    .00646    .00622    .00600    .00579    .00560    .00541
4...................................................    .00786    .00752    .00721    .00692    .00665    .00639    .00616    .00594    .00573    .00554
5...................................................    .00824    .00788    .00755    .00724    .00695    .00668    .00643    .00620    .00598    .00578
6...................................................    .00869    .00832    .00796    .00764    .00733    .00705    .00678    .00654    .00630    .00608
7...................................................    .00923    .00883    .00846    .00811    .00779    .00749    .00720    .00694    .00669    .00646
8...................................................    .00986    .00943    .00904    .00867    .00833    .00801    .00771    .00743    .00716    .00692
9...................................................    .01059    .01014    .00972    .00933    .00897    .00863    .00831    .00801    .00773    .00747
10..................................................    .01142    .01095    .01051    .01009    .00971    .00935    .00901    .00869    .00840    .00812
11..................................................    .01239    .01189    .01142    .01098    .01057    .01019    .00983    .00950    .00918    .00889
12..................................................    .01345    .01292    .01243    .01197    .01154    .01113    .01075    .01040    .01007    .00975
13..................................................    .01457    .01401    .01349    .01300    .01255    .01212    .01172    .01135    .01100    .01067
14..................................................    .01567    .01508    .01453    .01402    .01354    .01309    .01267    .01227    .01190    .01155
15..................................................    .01672    .01610    .01552    .01498    .01448    .01400    .01356    .01314    .01275    .01238
16..................................................    .01772    .01707    .01646    .01589    .01536    .01486    .01439    .01396    .01354    .01315
17..................................................    .01866    .01798    .01734    .01674    .01618    .01566    .01516    .01470    .01427    .01386
18..................................................    .01958    .01886    .01818    .01755    .01697    .01641    .01590    .01541    .01495    .01452
19..................................................    .02050    .01974    .01903    .01837    .01775    .01717    .01662    .01611    .01563    .01517
20..................................................    .02143    .02064    .01989    .01919    .01854    .01793    .01735    .01681    .01630    .01582
21..................................................    .02238    .02154    .02075    .02002    .01933    .01868    .01807    .01750    .01696    .01646
22..................................................    .02336    .02247    .02164    .02087    .02014    .01946    .01882    .01821    .01764    .01711
23..................................................    .02438    .02345    .02257    .02176    .02099    .02027    .01959    .01895    .01835    .01778
24..................................................    .02550    .02451    .02359    .02273    .02192    .02115    .02044    .01976    .01913    .01853
25..................................................    .02673    .02569    .02472    .02381    .02295    .02214    .02138    .02067    .01999    .01936
26..................................................    .02811    .02701    .02598    .02502    .02411    .02326    .02246    .02170    .02098    .02031
27..................................................    .02965    .02849    .02741    .02639    .02543    .02452    .02367    .02287    .02211    .02140
28..................................................    .03134    .03013    .02898    .02790    .02689    .02593    .02503    .02418    .02338    .02262
29..................................................    .03322    .03193    .03072    .02958    .02851    .02750    .02654    .02564    .02479    .02398
30..................................................    .03527    .03391    .03264    .03143    .03030    .02923    .02821    .02726    .02635    .02550
31..................................................    .03753    .03610    .03475    .03348    .03228    .03115    .03008    .02907    .02811    .02720
32..................................................    .04000    .03849    .03707    .03573    .03446    .03326    .03213    .03105    .03004    .02907
33..................................................    .04269    .04111    .03961    .03819    .03685    .03558    .03438    .03325    .03217    .03115
34..................................................    .04561    .04394    .04236    .04087    .03946    .03812    .03685    .03565    .03451    .03342
35..................................................    .04877    .04702    .04535    .04378    .04229    .04087    .03953    .03826    .03706    .03591
36..................................................    .05215    .05031    .04856    .04690    .04533    .04384    .04242    .04108    .03980    .03859
37..................................................    .05578    .05384    .05200    .05025    .04860    .04703    .04553    .04411    .04276    .04148
38..................................................    .05965    .05761    .05568    .05385    .05211    .05045    .04888    .04738    .04595    .04460
39..................................................    .06379    .06165    .05962    .05770    .05587    .05412    .05247    .05089    .04939    .04795
40..................................................    .06820    .06596    .06383    .06181    .05989    .05806    .05631    .05465    .05307    .05155
41..................................................    .07288    .07054    .06832    .06620    .06418    .06226    .06042    .05868    .05701    .05541
42..................................................    .07784    .07539    .07306    .07085    .06873    .06671    .06479    .06295    .06119    .05952
43..................................................    .08308    .08052    .07808    .07576    .07355    .07143    .06941    .06748    .06564    .06387
44..................................................    .08861    .08594    .08340    .08097    .07865    .07644    .07432    .07230    .07036    .06851
45..................................................    .09445    .09167    .08901    .08648    .08406    .08174    .07953    .07741    .07538    .07343
46..................................................    .10060    .09770    .09494    .09230    .08977    .08735    .08503    .08281    .08068    .07865
47..................................................    .10707    .10406    .10119    .09843    .09579    .09327    .09085    .08853    .08630    .08417
48..................................................    .11386    .11073    .10774    .10487    .10213    .09949    .09697    .09455    .09222    .08999
49..................................................    .12094    .11769    .11458    .11160    .10874    .10600    .10337    .10084    .09842    .09609
50..................................................    .12831    .12494    .12172    .11862    .11565    .11280    .11006    .10743    .10490    .10247
51..................................................    .13600    .13251    .12917    .12596    .12288    .11991    .11706    .11432    .11169    .10915
52..................................................    .14405    .14044    .13698    .13366    .13046    .12738    .12442    .12157    .11883    .11619
53..................................................    .15247    .14875    .14517    .14172    .13841    .13522    .13215    .12919    .12635    .12360
54..................................................    .16124    .15740    .15370    .15014    .14671    .14341    .14023    .13717    .13421    .13136
55..................................................    .17039    .16642    .16261    .15893    .15539    .15198    .14868    .14551    .14244    .13948
56..................................................    .17991    .17583    .17190    .16811    .16445    .16092    .15752    .15423    .15106    .14799
57..................................................    .18984    .18564    .18160    .17769    .17392    .17029    .16677    .16338    .16010    .15692
58..................................................    .20018    .19587    .19172    .18770    .18382    .18007    .17645    .17295    .16956    .16628
59..................................................    .21093    .20652    .20225    .19812    .19414    .19028    .18655    .18294    .17945    .17606
60..................................................    .22206    .21753    .21316    .20893    .20483    .20087    .19703    .19332    .18972    .18624
61..................................................    .23353    .22890    .22442    .22009    .21589    .21182    .20788    .20407    .20037    .19678
62..................................................    .24532    .24059    .23601    .23158    .22728    .22311    .21907    .21515    .21135    .20767
63..................................................    .25742    .25260    .24793    .24339    .23900    .23473    .23060    .22658    .22268    .21890
64..................................................    .26987    .26495    .26019    .25556    .25107    .24671    .24248    .23837    .23438    .23050
65..................................................    .28271    .27771    .27286    .26815    .26357    .25912    .25480    .25059    .24651    .24254
66..................................................    .29601    .29093    .28600    .28120    .27654    .27200    .26760    .26331    .25913    .25507
67..................................................    .30978    .30462    .29961    .29474    .29000    .28539    .28090    .27653    .27227    .26813
68..................................................    .32401    .31879    .31371    .30877    .30396    .29927    .29471    .29027    .28593    .28171

[[Page 41]]

                                                                                                                                                        
69..................................................    .33863    .33336    .32822    .32322    .31835    .31359    .30896    .30445    .30005    .29576
70..................................................    .35361    .34829    .34310    .33804    .33311    .32830    .32361    .31903    .31457    .31021
71..................................................    .36886    .36349    .35826    .35316    .34818    .34332    .33858    .33394    .32942    .32500
72..................................................    .38439    .37899    .37373    .36858    .36356    .35866    .35387    .34919    .34461    .34015
73..................................................    .40021    .39479    .38950    .38432    .37927    .37433    .36950    .36478    .36016    .35565
74..................................................    .41639    .41096    .40565    .40046    .39538    .39042    .38556    .38081    .37616    .37161
75..................................................    .43301    .42758    .42226    .41706    .41198    .40699    .40212    .39734    .39267    .38809
76..................................................    .45009    .44467    .43937    .43417    .42908    .42410    .41921    .41443    .40974    .40514
77..................................................    .46761    .46221    .45693    .45175    .44667    .44170    .43682    .43203    .42734    .42274
78..................................................    .48548    .48013    .47488    .46973    .46468    .45972    .45486    .45009    .44541    .44082
79..................................................    .50356    .49826    .49306    .48795    .48294    .47802    .47319    .46845    .46379    .45922
80..................................................    .52171    .51647    .51133    .50628    .50132    .49644    .49166    .48695    .48233    .47779
81..................................................    .53974    .53457    .52950    .52451    .51961    .51479    .51006    .50541    .50083    .49633
82..................................................    .55753    .55245    .54745    .54254    .53771    .53296    .52828    .52369    .51917    .51472
83..................................................    .57500    .57001    .56510    .56026    .55551    .55083    .54623    .54170    .53724    .53285
84..................................................    .59216    .58726    .58245    .57770    .57304    .56844    .56391    .55945    .55506    .55074
85..................................................    .60906    .60428    .59956    .59492    .59034    .58583    .58139    .57702    .57270    .56845
86..................................................    .62555    .62088    .61627    .61173    .60725    .60284    .59849    .59420    .58997    .58580
87..................................................    .64139    .63683    .63233    .62790    .62352    .61921    .61495    .61076    .60661    .60253
88..................................................    .65666    .65221    .64783    .64350    .63923    .63502    .63086    .62675    .62270    .61871
89..................................................    .67163    .66730    .66304    .65882    .65466    .65055    .64650    .64249    .63854    .63463
90..................................................    .68646    .68226    .67812    .67402    .66998    .66599    .66204    .65814    .65430    .65049
91..................................................    .70093    .69686    .69285    .68888    .68496    .68108    .67725    .67347    .66973    .66604
92..................................................    .71466    .71073    .70684    .70300    .69920    .69545    .69173    .68806    .68444    .68085
93..................................................    .72750    .72370    .71994    .71622    .71254    .70890    .70530    .70174    .69822    .69474
94..................................................    .73931    .73562    .73198    .72838    .72481    .72129    .71780    .71434    .71093    .70755
95..................................................    .75001    .74644    .74291    .73941    .73595    .73253    .72914    .72579    .72247    .71919
96..................................................    .75953    .75606    .75262    .74923    .74586    .74253    .73924    .73598    .73275    .72955
97..................................................    .76819    .76481    .76147    .75816    .75489    .75165    .74844    .74526    .74211    .73899
98..................................................    .77599    .77270    .76944    .76621    .76302    .75986    .75672    .75362    .75054    .74750
99..................................................    .78319    .77998    .77680    .77365    .77053    .76744    .76437    .76134    .75833    .75535
100.................................................    .78987    .78673    .78362    .78054    .77748    .77446    .77146    .76849    .76555    .76263
101.................................................    .79622    .79315    .79010    .78708    .78409    .78113    .77819    .77528    .77239    .76953
102.................................................    .80283    .79983    .79685    .79390    .79097    .78807    .78519    .78234    .77951    .77671
103.................................................    .80983    .80690    .80399    .80111    .79825    .79541    .79260    .78981    .78705    .78430
104.................................................    .81760    .81475    .81192    .80912    .80633    .80357    .80083    .79810    .79541    .79273
105.................................................    .82726    .82451    .82178    .81907    .81638    .81371    .81106    .80843    .80582    .80322
106.................................................    .84137    .83879    .83623    .83368    .83115    .82863    .82614    .82366    .82119    .81874
107.................................................    .86211    .85981    .85751    .85523    .85297    .85071    .84847    .84624    .84403    .84182
108.................................................    .89660    .89481    .89304    .89127    .88950    .88775    .88601    .88427    .88254    .88081
109.................................................    .95372    .95290    .95208    .95126    .95045    .94964    .94883    .94803    .94723    .94643
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 42]]


                                           Table S.--Based on Life Table 80CNSMT Single Life Remainder Factors                                          
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                 Interest rate                                          
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01683    .01669    .01655    .01642    .01630    .01618    .01607    .01596    .01586    .01576
1...................................................    .00559    .00544    .00531    .00518    .00506    .00494    .00484    .00473    .00464    .00454
2...................................................    .00528    .00513    .00499    .00485    .00473    .00461    .00449    .00439    .00428    .00419
3...................................................    .00524    .00508    .00493    .00479    .00465    .00453    .00441    .00429    .00419    .00408
4...................................................    .00536    .00519    .00503    .00488    .00473    .00460    .00447    .00435    .00423    .00412
5...................................................    .00558    .00540    .00523    .00507    .00492    .00477    .00464    .00451    .00439    .00427
6...................................................    .00588    .00569    .00550    .00533    .00517    .00502    .00487    .00473    .00460    .00448
7...................................................    .00624    .00604    .00584    .00566    .00549    .00532    .00517    .00502    .00488    .00475
8...................................................    .00668    .00646    .00626    .00606    .00588    .00570    .00554    .00538    .00523    .00509
9...................................................    .00722    .00699    .00677    .00656    .00636    .00617    .00600    .00583    .00567    .00552
10..................................................    .00785    .00761    .00737    .00715    .00694    .00674    .00655    .00637    .00620    .00604
11..................................................    .00861    .00835    .00810    .00786    .00764    .00743    .00723    .00704    .00686    .00668
12..................................................    .00946    .00918    .00891    .00866    .00843    .00820    .00799    .00779    .00760    .00741
13..................................................    .01035    .01006    .00978    .00951    .00927    .00903    .00880    .00859    .00839    .00819
14..................................................    .01122    .01091    .01061    .01034    .01007    .00982    .00958    .00936    .00914    .00894
15..................................................    .01203    .01171    .01140    .01110    .01082    .01056    .01031    .01007    .00985    .00963
16..................................................    .01279    .01244    .01211    .01181    .01151    .01123    .01097    .01072    .01048    .01025
17..................................................    .01347    .01311    .01276    .01244    .01213    .01184    .01156    .01130    .01104    .01081
18..................................................    .01411    .01373    .01336    .01302    .01270    .01239    .01210    .01182    .01155    .01130
19..................................................    .01474    .01434    .01396    .01359    .01325    .01293    .01262    .01233    .01205    .01178
20..................................................    .01537    .01494    .01454    .01415    .01379    .01345    .01313    .01282    .01252    .01224
21..................................................    .01598    .01553    .01510    .01470    .01432    .01396    .01361    .01329    .01298    .01268
22..................................................    .01660    .01613    .01568    .01525    .01485    .01446    .01410    .01375    .01343    .01312
23..................................................    .01725    .01674    .01627    .01581    .01539    .01498    .01460    .01423    .01388    .01355
24..................................................    .01796    .01742    .01692    .01644    .01599    .01556    .01515    .01476    .01439    .01404
25..................................................    .01876    .01819    .01765    .01714    .01666    .01621    .01577    .01536    .01497    .01460
26..................................................    .01967    .01907    .01850    .01796    .01745    .01696    .01650    .01606    .01565    .01525
27..................................................    .02072    .02008    .01948    .01890    .01836    .01784    .01735    .01688    .01644    .01601
28..................................................    .02190    .02122    .02057    .01996    .01938    .01883    .01831    .01781    .01734    .01689
29..................................................    .02322    .02249    .02181    .02116    .02054    .01996    .01940    .01887    .01836    .01788
30..................................................    .02469    .02392    .02319    .02250    .02184    .02122    .02062    .02006    .01952    .01900
31..................................................    .02634    .02552    .02475    .02401    .02331    .02264    .02201    .02140    .02083    .02028
32..................................................    .02816    .02729    .02647    .02568    .02494    .02423    .02355    .02291    .02229    .02170
33..................................................    .03018    .02926    .02838    .02755    .02675    .02600    .02528    .02459    .02393    .02331
34..................................................    .03239    .03142    .03048    .02960    .02875    .02795    .02718    .02645    .02575    .02508
35..................................................    .03482    .03378    .03279    .03185    .03095    .03009    .02928    .02850    .02775    .02704
36..................................................    .03743    .03633    .03528    .03428    .03333    .03242    .03155    .03072    .02992    .02916
37..................................................    .04026    .03909    .03798    .03692    .03591    .03494    .03401    .03313    .03228    .03147
38..................................................    .04330    .04207    .04089    .03977    .03869    .03767    .03668    .03574    .03484    .03398
39..................................................    .04658    .04528    .04403    .04284    .04170    .04061    .03957    .03857    .03762    .03670
40..................................................    .05011    .04873    .04741    .04615    .04495    .04379    .04269    .04163    .04061    .03964
41..................................................    .05389    .05244    .05104    .04971    .04844    .04721    .04604    .04492    .04384    .04281
42..................................................    .05791    .05638    .05491    .05350    .05216    .05086    .04962    .04844    .04729    .04620
43..................................................    .06219    .06057    .05902    .05754    .05612    .05475    .05344    .05218    .05098    .04981
44..................................................    .06673    .06503    .06340    .06184    .06034    .05890    .05752    .05619    .05491    .05368
45..................................................    .07157    .06978    .06806    .06642    .06484    .06332    .06186    .06046    .05911    .05781
46..................................................    .07669    .07481    .07301    .07128    .06962    .06802    .06649    .06501    .06358    .06221
47..................................................    .08212    .08015    .07826    .07645    .07470    .07302    .07140    .06984    .06834    .06690
48..................................................    .08784    .08578    .08380    .08190    .08006    .07830    .07660    .07496    .07338    .07186
49..................................................    .09384    .09169    .08961    .08762    .08570    .08384    .08206    .08034    .07868    .07708
50..................................................    .10013    .09787    .09570    .09361    .09160    .08966    .08779    .08598    .08424    .08256
51..................................................    .10671    .10436    .10209    .09991    .09780    .09577    .09381    .09192    .09009    .08832
52..................................................    .11365    .11120    .10883    .10655    .10435    .10222    .10017    .09819    .09628    .09442
53..................................................    .12095    .11840    .11593    .11355    .11126    .10904    .10689    .10482    .10282    .10088
54..................................................    .12860    .12595    .12338    .12090    .11851    .11619    .11396    .11179    .10970    .10767
55..................................................    .13663    .13386    .13120    .12862    .12613    .12372    .12138    .11912    .11694    .11482
56..................................................    .14503    .14217    .13940    .13672    .13413    .13162    .12919    .12683    .12456    .12235
57..................................................    .15385    .15089    .14801    .14523    .14254    .13994    .13741    .13496    .13259    .13029
58..................................................    .16311    .16004    .15706    .15418    .15139    .14868    .14606    .14352    .14105    .13866
59..................................................    .17279    .16961    .16654    .16355    .16066    .15786    .15514    .15250    .14994    .14745
60..................................................    .18286    .17958    .17640    .17332    .17033    .16743    .16462    .16188    .15922    .15664
61..................................................    .19330    .18992    .18665    .18347    .18038    .17738    .17447    .17164    .16889    .16622
62..................................................    .20409    .20061    .19724    .19396    .19078    .18768    .18467    .18175    .17891    .17614
63..................................................    .21522    .21165    .20818    .20480    .20152    .19833    .19523    .19221    .18928    .18642
64..................................................    .22672    .22306    .21949    .21602    .21265    .20937    .20617    .20306    .20003    .19708
65..................................................    .23867    .23491    .23125    .22769    .22423    .22085    .21757    .21437    .21125    .20821
66..................................................    .25112    .24727    .24353    .23988    .23632    .23286    .22948    .22619    .22299    .21986
67..................................................    .26409    .26016    .25633    .25260    .24896    .24541    .24195    .23857    .23528    .23206
68..................................................    .27760    .27359    .26968    .26586    .26214    .25851    .25497    .25151    .24814    .24484

[[Page 43]]

                                                                                                                                                        
69..................................................    .29157    .28748    .28350    .27961    .27581    .27211    .26849    .26495    .26150    .25812
70..................................................    .30596    .30181    .29775    .29379    .28992    .28614    .28245    .27884    .27532    .27187
71..................................................    .32069    .31648    .31236    .30833    .30440    .30055    .29679    .29312    .28952    .28600
72..................................................    .33578    .33151    .32733    .32325    .31925    .31535    .31152    .30778    .30412    .30054
73..................................................    .35123    .34691    .34269    .33855    .33450    .33054    .32666    .32286    .31914    .31550
74..................................................    .36715    .36279    .35852    .35434    .35024    .34623    .34230    .33845    .33468    .33098
75..................................................    .38360    .37921    .37491    .37069    .36656    .36250    .35853    .35464    .35082    .34708
76..................................................    .40064    .39623    .39190    .38765    .38349    .37941    .37540    .37148    .36762    .36384
77..................................................    .41823    .41381    .40947    .40521    .40103    .39692    .39290    .38895    .38507    .38126
78..................................................    .43632    .43189    .42755    .42329    .41910    .41499    .41095    .40698    .40309    .39926
79..................................................    .45473    .45032    .44599    .44173    .43755    .43344    .42940    .42543    .42153    .41770
80..................................................    .47333    .46894    .46463    .46040    .45623    .45213    .44811    .44414    .44025    .43642
81..................................................    .49191    .48755    .48328    .47907    .47493    .47085    .46684    .46290    .45902    .45520
82..................................................    .51034    .50603    .50179    .49762    .49351    .48947    .48549    .48157    .47772    .47392
83..................................................    .52852    .52427    .52008    .51595    .51189    .50788    .50394    .50006    .49623    .49246
84..................................................    .54648    .54228    .53815    .53407    .53006    .52610    .52221    .51836    .51458    .51084
85..................................................    .56426    .56013    .55606    .55205    .54810    .54420    .54035    .53656    .53282    .52913
86..................................................    .58169    .57764    .57364    .56970    .56581    .56197    .55818    .55445    .55076    .54713
87..................................................    .59850    .59452    .59060    .58673    .58291    .57913    .57541    .57174    .56811    .56453
88..................................................    .61476    .61086    .60702    .60322    .59947    .59577    .59212    .58851    .58494    .58142
89..................................................    .63078    .62697    .62321    .61950    .61583    .61220    .60862    .60508    .60159    .59813
90..................................................    .64674    .64302    .63935    .63573    .63215    .62861    .62511    .62165    .61823    .61485
91..................................................    .66238    .65877    .65520    .65167    .64819    .64474    .64133    .63795    .63462    .63132
92..................................................    .67730    .67379    .67032    .66689    .66350    .66014    .65682    .65354    .65029    .64708
93..................................................    .69130    .68789    .68452    .68119    .67789    .67463    .67140    .66820    .66504    .66191
94..................................................    .70421    .70090    .69762    .69438    .69118    .68800    .68486    .68175    .67867    .67563
95..................................................    .71594    .71272    .70954    .70639    .70326    .70017    .69712    .69409    .69109    .68812
96..................................................    .72638    .72325    .72014    .71707    .71403    .71101    .70803    .70507    .70215    .69925
97..................................................    .73590    .73285    .72982    .72682    .72385    .72090    .71799    .71510    .71224    .70941
98..................................................    .74448    .74149    .73853    .73560    .73269    .72981    .72696    .72414    .72134    .71856
99..................................................    .75240    .74948    .74658    .74371    .74086    .73805    .73525    .73248    .72974    .72702
100.................................................    .75974    .75687    .75403    .75121    .74842    .74566    .74292    .74020    .73751    .73484
101.................................................    .76669    .76388    .76109    .75833    .75559    .75287    .75018    .74751    .74486    .74223
102.................................................    .77393    .77117    .76844    .76573    .76304    .76037    .75773    .75511    .75251    .74993
103.................................................    .78158    .77888    .77620    .77355    .77091    .76830    .76571    .76313    .76058    .75805
104.................................................    .79007    .78743    .78482    .78222    .77964    .77709    .77455    .77203    .76953    .76705
105.................................................    .80065    .79809    .79556    .79304    .79054    .78805    .78559    .78314    .78071    .77829
106.................................................    .81631    .81389    .81149    .80911    .80674    .80438    .80204    .79972    .79741    .79511
107.................................................    .83963    .83745    .83529    .83313    .83099    .82886    .82674    .82463    .82254    .82045
108.................................................    .87910    .87739    .87569    .87400    .87232    .87064    .86897    .86731    .86566    .86401
109.................................................    .94563    .94484    .94405    .94326    .94248    .94170    .94092    .94014    .93937    .93860
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 44]]

    (f) Effective date. This section is effective as of May 1, 1989.

[T.D. 7105, 36 FR 6480, Apr. 6, 1971; 36 FR 9512, May 26, 1971; 36 FR 
12290, June 30, 1971, as amended by T.D. 7955, 49 FR 19976, May 11, 
1984; T.D. 8540, 59 FR 30105, June 10, 1994]



Sec. 1.642(c)-7   Transitional rules with respect to pooled income funds.

    (a) In general--(1) Amendment of certain funds. A fund created 
before May 7, 1971, and not otherwise qualifying as a pooled income fund 
may be treated as a pooled income fund to which Sec. 1.642(c)-5 applies 
if on July 31, 1969, or on each date of transfer of property to the fund 
occurring after July 31, 1969, it possessed the initial characteristics 
described in paragraph (b) of this section and is amended, in the time 
and manner provided in paragraph (c) of this section, to meet all the 
requirements of section 642(c)(5) and Sec. 1.642(c)-5. If a fund to 
which this subparagraph applies is amended in the time and manner 
provided in paragraph (c) of this section it shall be treated as 
provided in paragraph (d) of this section for the period beginning on 
August 1, 1969, or, if later, on the date of its creation and ending the 
day before the date on which it meets the requirements of section 
642(c)(5) and Sec. 1.642(c)-5.
    (2) Severance of a portion of a fund. Any portion of a fund created 
before May 7, 1971, which consists of property transferred to such fund 
after July 31, 1969, may be severed from such fund consistently with the 
principles of paragraph (c)(2) of this section and established before 
January 1, 1972, as a separate pooled income fund, provided that on and 
after the date of severance the severed fund meets all the requirements 
of section 642(c)(5) and Sec. 1.642(c)-5. A separate fund which is 
established pursuant to this subparagraph shall be treated as provided 
in paragraph (d) of this section for the period beginning on the day of 
the first transfer of property which becomes part of the separate fund 
and ending the day before the day on which the separate fund meets the 
requirements of section 642(c)(5) and Sec. 1.642(c)-5.
    (b) Initial characteristics required. A fund described in paragraph 
(a)(1) of this section shall not be treated as a pooled income fund to 
which section 642(c)(5) applies, even though it is amended as provided 
in paragraph (c) of this section, unless it possessed the following 
characteristics on July 31, 1969, or on each date of transfer of 
property to the fund occurring after July 31, 1969:
    (1) It satisfied the requirements of section 642(c)(5)(A) other than 
that the fund be a trust;
    (2) It was constituted in a way to attract and contain commingled 
properties transferred to the fund by more than one donor satisfying 
such requirements; and
    (3) Each beneficiary of a life income interest which was retained or 
created in any property transferred to the fund was entitled to receive, 
but not less often than annually, a proportional share of the annual 
income earned by the fund, such share being based on the fair market 
value of the property in which such life interest was retained or 
created.
    (c) Amendment requirements. (1) A fund described in paragraph (a)(1) 
of this section and possessing the initial characteristics described in 
paragraph (b) of this section on the date prescribed therein shall be 
treated as a pooled income fund if it is amended to meet all the 
requirements of section 642(c)(5) and Sec. 1.642(c)-5 before January 1, 
1972, or, if later, on or before the 30th day after the date on which 
any judicial proceedings commenced before January 1, 1972, which are 
required to amend its governing instrument or any other instrument which 
does not permit it to meet such requirements, become final. However, see 
paragraph (d) of this section for limitation on the period in which a 
claim for credit or refund may be filed.
    (2) In addition, if the transferred property described in paragraph 
(b)(2) of this section is commingled with other property, the 
transferred property must be separated on or before the date specified 
in subparagraph (1) of this paragraph from the other property and 
allocated to the fund in accordance with the transferred property's 
percentage share of the fair market value of the total commingled 
property on the date of separation. The percentage share shall be the 
ratio which the fair

[[Page 45]]

market value of the transferred property on the date of separation bears 
to the fair market value of the total commingled property on that date 
and shall be computed in a manner consistent with paragraph (c) of 
Sec. 1.642(c)-5. The property which is so allocated to the fund shall be 
treated as property received from transfers which meet the requirements 
of section 642(c)(5), and such transfers shall be treated as made on the 
dates on which the properties giving rise to such allocation were 
transferred to the fund by the respective donors. The property so 
allocated to the fund must be representative of all the commingled 
property other than securities the income from which is exempt from tax 
under subtitle A of the Code; compensating increases in other commingled 
property allocated to the fund shall be made where such tax-exempt 
securities are not allocated to the fund. The application of this 
subparagraph may be illustrated by the following example:

    Example. (a) The trustees of X fund are in the process of amending 
it in order to qualify as a pooled income fund. The property transferred 
to the X fund was commingled with other property transferred to the 
organization by which the fund was established. After taking into 
account the various transfers and the appreciation in the fair market 
value of all the properties, the fair market value of the property 
allocated to the fund on the various transfer dates is set forth in the 
following schedule and determined in the manner indicated:

                                                    Transfers                                                   
----------------------------------------------------------------------------------------------------------------
                                               Value of all     Trust      Other     Value of all     Property  
                                                 property      property   property  property after  allocated to
                                                  before     ----------------------    transfer         fund    
              Date of transfer                   transfer                          -----------------------------
                                             ----------------    (2)        (3)                                 
                                                    (1)                                   (4)            (5)    
----------------------------------------------------------------------------------------------------------------
January 1, 1968.............................  ..............   $100,000   $100,000     $200,000     \1\$100,000 
September 30, 1968..........................     $300,000       100,000  .........      400,000     \2\250,000  
January 15, 1969............................      480,000        60,000  .........      540,000     \3\360,000  
November 11, 1969...........................      600,000       200,000  .........      800,000     \4\600,000  
----------------------------------------------------------------------------------------------------------------
\1\$100,000=(the amount in column (2)).                                                                         
\2\$250,000=([$100,000/$200,000 x $300,000]+$100,000).                                                          
\3\$360,000=([$250,000/$400,000 x $480,000]+$60,000).                                                           
\4\$600,000=([$360,000/$540,000 x $600,000]+$200,000).                                                          

    (b) On September 30, 1970, the trustees decide to separate the 
property of X fund from the other property. The fair market value of all 
the commingled property is $1 million on September 30, 1970, and there 
were no additional transfers to the fund after November 11, 1969. 
Accordingly, the fair market value of the property required to be 
allocated to X fund must be $750,000 ($600,000/$800,000 x $1,000,000), 
and X fund's percentage share of the commingled property is 75 percent 
($750,000/$1,000,000). Accordingly, assuming that the commingled 
property consists of Y stock with a fair market value of $800,000 and Z 
bonds with a fair market value of $200,000, there must be allocated to X 
fund at the close of September 30, 1970, Y stock with a value of 
$600,000 ($800,000 x 75%) and Z bonds with a value of $150,000 
($200,000 x 75%).

    (d) Transactions before amendment of or severance from fund. (1) A 
fund which is amended pursuant to paragraph (c) of this section, or is 
severed from a fund pursuant to paragraph (a)(2) of this section, shall 
be treated for all purposes, including the allowance of a deduction for 
any charitable contribution, as if it were before its amendment or 
severance a pooled income fund to which section 642(c)(5) and 
Sec. 1.642(c)-5 apply. Thus, for example, where a donor transferred 
property in trust to such an amended or severed fund on August 1, 1969, 
but before its amendment or severance under this section, a charitable 
contributions deduction for the value of the remainder interest may be 
allowed under section 170, 2055, 2106, or 2522. The deduction may not be 
allowed, however, until the fund is amended or severed pursuant to this 
section and shall be allowed only if a claim for credit or refund is 
filed within the period of limitation prescribed by section 6511(a).

[[Page 46]]

    (2) For purposes of determining under Sec. 1.642(c)-6 the highest 
yearly rate of return earned by a fund (which is amended pursuant to 
paragraph (c) of this section) for the 3 preceding taxable years, 
taxable years of the fund preceding its taxable year in which the fund 
is so amended and qualifies as a pooled income fund under this section 
shall be used provided that the fund did not at any time during such 
preceding years hold any investments in securities the income from which 
is exempt from tax under subtitle A of the Code. If any such tax-exempt 
securities were held during such period by such amended fund, or if the 
fund consists of a portion of a fund which is severed pursuant to 
paragraph (a)(2) of this section, the highest yearly rate of return 
under Sec. 1.642(c)-6 shall be determined by treating the fund as a 
pooled income fund which has been in existence for less than 3 taxable 
years preceding the taxable year in which the transfer of property to 
the fund is made.
    (3) Property transferred to a fund before its amendment pursuant to 
paragraph (c) of this section, or before its severance under paragraph 
(a)(2) of this section, shall be treated as property received from 
transfers which meet the requirements of section 642(c)(5).

[T.D. 7105, 36 FR 6486, Apr. 6, 1971, as amended by T.D. 7125, 36 FR 
11032, June 8, 1971; T.D. 8540, 59 FR 30102, June 10, 1994]



Sec. 1.642(d)-1   Net operating loss deduction.

    The net operating loss deduction allowed by section 172 is available 
to estates and trusts generally, with the following exceptions and 
limitations:
    (a) In computing gross income and deductions for the purposes of 
section 172, a trust shall exclude that portion of the income and 
deductions attributable to the grantor or another person under sections 
671 through 678 (relating to grantors and others treated as substantial 
owners).
    (b) An estate or trust shall not, for the purposes of section 172, 
avail itself of the deductions allowed by section 642(c) (relating to 
charitable contributions deductions) and sections 651 and 661 (relating 
to deductions for distributions).



Sec. 1.642(e)-1  Depreciation and depletion.

    An estate or trust is allowed the deductions for depreciation and 
depletion, but only to the extent the deductions are not apportioned to 
beneficiaries under sections 167(h) and 611(b). For purposes of sections 
167(h) and 611(b), the term beneficiaries includes charitable 
beneficiaries. See the regulations under those sections.

[T.D. 6712, 29 FR 3655, Mar. 24, 1964]



Sec. 1.642(f)-1  Amortization deductions.

    An estate or trust is allowed amortization deductions with respect 
to an emergency facility as defined in section 168(d), with respect to a 
certified pollution control facility as defined in section 169(d), with 
respect to qualified railroad rolling stock as defined in section 
184(d), with respect to certified coal mine safety equipment as defined 
in section 187(d), with respect to on-the-job training and child-care 
facilities as defined in section 188(b), and with respect to certain 
rehabilitations of certified historic structures as defined in section 
191, in the same manner and to the same extent as in the case of an 
individual. However, the principles governing the apportionment of the 
deductions for depreciation and depletion between fiduciaries and the 
beneficiaries of an estate or trust (see sections 167(h) and 611(b) and 
the regulations thereunder) shall be applicable with respect to such 
amortization deductions.

[T.D. 7700, 45 FR 38055, June 6, 1980]



Sec. 1.642(g)-1   Disallowance of double deductions; in general.

    Amounts allowable under section 2053(a)(2) (relating to 
administration expenses) or under section 2054 (relating to losses 
during administration) as deductions in computing the taxable estate of 
a decedent are not allowed as deductions in computing the taxable income 
of the estate unless there is filed a statement, in duplicate, to the 
effect that the items have not been allowed as deductions from the gross 
estate of the decedent under section 2053 or 2054 and that all rights to 
have such items allowed at any time as deductions under section 2053 or 
2054 are

[[Page 47]]

waived. The statement should be filed with the return for the year for 
which the items are claimed as deductions or with the district director 
for the internal revenue district in which the return was filed, for 
association with the return. The statement may be filed at any time 
before the expiration of the statutory period of limitation applicable 
to the taxable year for which the deduction is sought. Allowance of a 
deduction in computing an estate's taxable income is not precluded by 
claiming a deduction in the estate tax return, so long as the estate tax 
deduction is not finally allowed and the statement is filed. However, 
after a statement is filed under section 642(g) with respect to a 
particular item or portion of an item, the item cannot thereafter be 
allowed as a deduction for estate tax purposes since the waiver operates 
as a relinquishment of the right to have the deduction allowed at any 
time under section 2053 or 2054.



Sec. 1.642(g)-2  Deductions included.

    It is not required that the total deductions, or the total amount of 
any deduction, to which section 642(g) is applicable be treated in the 
same way. One deduction or portion of a deduction may be allowed for 
income tax purposes if the appropriate statement is filed, while another 
deduction or portion is allowed for estate tax purposes. Section 642(g) 
has no application to deductions for taxes, interest, business expenses, 
and other items accrued at the date of a decedent's death so that they 
are allowable as a deduction under section 2053(a)(3) for estate tax 
purposes as claims against the estate, and are also allowable under 
section 691(b) as deductions in respect of a decedent for income tax 
purposes. However, section 642(g) is applicable to deductions for 
interest, business expenses, and other items not accrued at the date of 
the decedent's death so that they are allowable as deductions for estate 
tax purposes only as administration expenses under section 2053(a)(2). 
Although deductible under section 2053(a)(3) in determining the value of 
the taxable estate of a decedent, medical, dental, etc., expenses of a 
decedent which are paid by the estate of the decedent are not deductible 
in computing the taxable income of the estate. See section 213(d) and 
the regulations thereunder for rules relating to the deductibility of 
such expenses in computing the taxable income of the decedent.



Sec. 1.642(h)-1  Unused loss carryovers on termination of an estate or trust.

    (a) If, on the final termination of an estate or trust, a net 
operating loss carryover under section 172 or a capital loss carryover 
under section 1212 would be allowable to the estate or trust in a 
taxable year subsequent to the taxable year of termination but for the 
termination, the carryover or carryovers are allowed under section 
642(h)(1) to the beneficiaries succeeding to the property of the estate 
or trust. See Sec. 1.641(b)-3 for the determination of when an estate or 
trust terminates.
    (b) The net operating loss carryover and the capital loss carryover 
are the same in the hands of a beneficiary as in the estate or trust, 
except that the capital loss carryover in the hands of a beneficiary 
which is a corporation is a short-term loss irrespective of whether it 
would have been a long-term or short-term capital loss in the hands of 
the estate or trust. The net operating loss carryover and the capital 
loss carryover are taken into account in computing taxable income, 
adjusted gross income, and the tax imposed by section 56 (relating to 
the minimum tax for tax preferences). The first taxable year of the 
beneficiary to which the loss shall be carried over is the taxable year 
of the beneficiary in which or with which the estate or trust 
terminates. However, for purposes of determining the number of years to 
which a net operating loss, or a capital loss under paragraph (a) of 
Sec. 1.1212-1, may be carried over by a beneficiary, the last taxable 
year of the estate or trust (whether or not a short taxable year) and 
the first taxable year of the beneficiary to which a loss is carried 
over each constitute a taxable year, and, in the case of a beneficiary 
of an estate or trust that is a corporation, capital losses carried over 
by the estate or trust to any taxable year of the estate or trust 
beginning after December 31, 1963, shall be treated as if they were 
incurred in the last taxable year of the estate or trust (whether or not 
a short taxable

[[Page 48]]

year). For the treatment of the net operating loss carryover when the 
last taxable year of the estate or trust is the last taxable year to 
which such loss can be carried over, see Sec. 1.642(h)-2.
    (c) The application of this section may be illustrated by the 
following examples:

    Example 1. A trust distributes all of its assets to A, the sole 
remainderman, and terminates on December 31, 1954, when it has a capital 
loss carryover of $10,000 attributable to transactions during the 
taxable year 1952. A, who reports on the calendar year basis, otherwise 
has ordinary income of $10,000 and capital gains of $4,000 for the 
taxable year 1954. A would offset his capital gains of $4,000 against 
the capital loss of the trust and, in addition, deduct under section 
1211(b) $1,000 on his return for the taxable year 1954. The balance of 
the capital loss carryover of $5,000 may be carried over only to the 
years 1955 and 1956, in accordance with paragraph (a) of Sec. 1.1212-1 
and the rules of this section.
    Example 2. A trust distributes all of its assets, one-half to A, an 
individual, and one-half to X, a corporation, who are the sole 
remaindermen, and terminates on December 31, 1966, when it has a short-
term capital loss carryover of $20,000 attributable to short-term 
transactions during the taxable years 1964, 1965, and 1966, and a long-
term capital loss carryover of $12,000 attributable to long-term 
transactions during such years. A, who reports on the calendar year 
basis, otherwise has ordinary income of $15,000, short-term capital 
gains of $4,000 and long-term capital gains of $6,000, for the taxable 
year 1966. A would offset his short-term capital gains of $4,000 against 
his share of the short-term capital loss carryover of the trust, $10,000 
(one-half of $20,000), and, in addition deduct under section 1211(b) 
$1,000 (treated as a short-term gain for purposes of computing capital 
loss carryovers) on his return for the taxable year 1966. A would also 
offset his long-term capital gains of $6,000 against his share of the 
long-term capital loss carryover of the trust, $6,000 (one-half of 
$12,000). The balance of A's share of the short-term capital loss 
carryover, $5,000, may be carried over as a short-term capital loss 
carryover to the succeeding taxable year and treated as a short-term 
capital loss incurred in such succeeding taxable year in accordance with 
paragraph (b) of Sec. 1.1212-1. X, which also reports on the calendar 
year basis, otherwise has capital gains of $4,000 for the taxable year 
1966. X would offset its capital gains of $4,000 against its share of 
the capital loss carryovers of the trust, $16,000 (the sum of one-half 
of each the short-term carryover and the long-term carryover of the 
trust), on its return for the taxable year 1966. The balance of X's 
share, $12,000, may be carried over as a short-term capital loss only to 
the years 1967, 1968, 1969, and 1970, in accordance with paragraph (a) 
of Sec. 1.1212-1 and the rules of this section.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6828, 30 FR 
7805, June 17, 1965; T.D. 7564, 43 FR 40495, Sept. 12, 1978]



Sec. 1.642(h)-2  Excess deductions on termination of an estate or trust.

    (a) If, on the termination of an estate or trust, the estate or 
trust has for its last taxable year deductions (other than the 
deductions allowed under section 642(b) (relating to personal exemption) 
or section 642(c) (relating to charitable contributions)) in excess of 
gross income, the excess is allowed under section 642(h)(2) as a 
deduction to the beneficiaries succeeding to the property of the estate 
or trust. The deduction is allowed only in computing taxable income and 
must be taken into account in computing the items of tax preference of 
the beneficiary; it is not allowed in computing adjusted gross income. 
The deduction is allowable only in the taxable year of the beneficiary 
in which or with which the estate or trust terminates, whether the year 
of termination of the estate or trust is of normal duration or is a 
short taxable year. For example: Assume that a trust distributes all of 
its assets to B and terminates on December 31, 1954. As of that date it 
has excess deductions, for example, because of corpus commissions on 
termination, of $18,000. B, who reported on the calendar year basis, 
could claim the $18,000 as a deduction for the taxable year 1954. 
However, if the deduction (when added to his other deductions) exceeds 
his gross income, the excess may not be carried over to the year 1955 or 
subsequent years.
    (b) A deduction based upon a net operating loss carryover will never 
be allowed to beneficiaries under both paragraphs (1) and (2) of section 
642(h). Accordingly, a net operating loss deduction which is allowable 
to beneficiaries succeeding to the property of the estate or trust under 
the provisions of paragraph (1) of section 642(h) cannot also be 
considered a deduction for purposes of paragraph (2) of section 642(h) 
and paragraph (a) of this section. However, if the last taxable year of 
the estate or trust is the last year in which

[[Page 49]]

a deduction on account of a net operating loss may be taken, the 
deduction, to the extent not absorbed in that taxable year by the estate 
or trust, is considered an ``excess deduction'' under section 642(h)(2) 
and paragraph (a) of this section.
    (c) Any item of income or deduction, or any part thereof, which is 
taken into account in determining the net operating loss or capital loss 
carryover of the estate or trust for its last taxable year shall not be 
taken into account again in determining excess deductions on termination 
of the trust or estate within the meaning of section 642(h)(2) and 
paragraph (a) of this section (see example in Sec. 1.642(h)-5).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7564, 43 FR 
40495, Sept. 12, 1978]



Sec. 1.642(h)-3  Meaning of ``beneficiaries succeeding to the property of the estate or trust''.

    (a) The phrase beneficiaries succeeding to the property of the 
estate or trust means those beneficiaries upon termination of the estate 
or trust who bear the burden of any loss for which a carryover is 
allowed, or of any excess of deductions over gross income for which a 
deduction is allowed, under section 642(h).
    (b) With reference to an intestate estate, the phrase means the 
heirs and next of kin to whom the estate is distributed, or if the 
estate is insolvent, to whom it would have been distributed if it had 
not been insolvent. If a decedent's spouse is entitled to a specified 
dollar amount of property before any distribution to other heirs and 
next of kin, and if the estate is less than that amount, the spouse is 
the beneficiary succeeding to the property of the estate or trust to the 
extent of the deficiency in amount.
    (c) In the case of a testate estate, the phrase normally means the 
residuary beneficiaries (including a residuary trust), and not specific 
legatees or devisees, pecuniary legatees, or other nonresiduary 
beneficiaries. However, the phrase does not include the recipient of a 
specific sum of money even though it is payable out of the residue, 
except to the extent that it is not payable in full. On the other hand, 
the phrase includes a beneficiary (including a trust) who is not 
strictly a residuary beneficiary but whose devise or bequest is 
determined by the value of the decedent's estate as reduced by the loss 
or deductions in question. Thus the phrase includes:
    (1) A beneficiary of a fraction of a decedent's net estate after 
payment of debts, expenses, etc.;
    (2) A nonresiduary legatee or devisee, to the extent of any 
deficiency in his legacy or devise resulting from the insufficiency of 
the estate to satisfy it in full;
    (3) A surviving spouse receiving a fractional share of an estate in 
fee under a statutory right of election, to the extent that the loss or 
deductions are taken into account in determining the share. However, the 
phrase does not include a recipient of dower or curtesy, or any income 
beneficiary of the estate or trust from which the loss or excess 
deduction is carried over.
    (d) The principles discussed in paragraph (c) of this section are 
equally applicable to trust beneficiaries. A remainderman who receives 
all or a fractional share of the property of a trust as a result of the 
final termination of the trust is a beneficiary succeeding to the 
property of the trust. For example, if property is transferred to pay 
the income to A for life and then to pay $10,000 to B and distribute the 
balance of the trust corpus to C, C and not B is considered to be the 
succeeding beneficiary except to the extent that the trust corpus is 
insufficient to pay B $10,000.



Sec. 1.642(h)-4  Allocation.

    The carryovers and excess deductions to which section 642(h) applies 
are allocated among the beneficiaries succeeding to the property of an 
estate or trust (see Sec. 1.642(h)-3) proportionately according to the 
share of each in the burden of the loss or deductions. A person who 
qualified as a beneficiary succeeding to the property of an estate or 
trust with respect to one amount and does not qualify with respect to 
another amount is a beneficiary succeeding to the property of the estate 
or trust as to the amount with respect to which he qualifies. The 
application of

[[Page 50]]

this section may be illustrated by the following example:

    Example. A decedent's will leaves $100,000 to A, and the residue of 
his estate equally to B and C. His estate is sufficient to pay only 
$90,000 to A, and nothing to B and C. There is an excess of deductions 
over gross income for the last taxable year of the estate or trust of 
$5,000, and a capital loss carryover of $15,000, to both of which 
section 642(h) applies. A is a beneficiary succeeding to the property of 
the estate to the extent of $10,000, and since the total of the excess 
of deductions and the loss carryover is $20,000, A is entitled to the 
benefit of one half of each item, and the remaining half is divided 
equally between B and C.



Sec. 1.642(h)-5  Example.

    The application of section 642(h) may be illustrated by the 
following example:

    Example. (a) A decedent dies January 31, 1954, leaving a will which 
provides for distributing all her estate equally to A and an existing 
trust for B. The period of administration of the estate terminates on 
December 31, 1954, at which time all the property of the estate is 
distributed to A and the trust. A reports his income for tax purposes on 
a calendar year basis, and the trust reports its income on the basis of 
a fiscal year ending August 31. During the period of the administration, 
the estate has the following items of income and deductions:

Taxable interest...........................................   $2,500    
Business income............................................    3,000    
                                                            ------------
    Total..................................................    5,500    
                                                            ============
Business expenses (including administrative expense                     
 allocable to business income).............................    5,000    
Administrative expenses and corpus commissions not                      
 allocable to business income..............................    9,800    
                                                            ------------
    Total deductions.......................................   14,800    
                                                                        

    It also has a capital loss of $5,000.
    (b) Under section 642(h)(1), an unused net operating loss carryover 
of the estate on termination of $2,000 will be allowable to: A to the 
extent of $1,000 for his taxable year 1954 and the next four taxable 
years in accordance with section 172; and to the trust to the extent of 
$1,000 for its taxable year ending August 31, 1955, and its next four 
taxable years. The amount of the net operating loss carryover is 
computed as follows:

Deductions of estate for 1954...........................     $14,800    
Less adjustment under section 172(d)(4) (deductions not                 
 attributable to a trade or business ($9,800) allowable                 
 only to extent of gross income not derived from such                   
 trade or business ($2,500))............................       7,300    
                                                         ---------------
  Deductions as adjusted................................       7,500    
Gross income of estate for 1954.........................       5,500    
                                                         ---------------
  Net operating loss of estate for 1954.................       2,000    
(No deduction for capital loss of $5,000 under section                  
 172(d)(2))                                                             
                                                                        

Neither A nor the trust will be allowed to carry back any part of the 
net operating loss made available to them under section 642(h)(1).
    (c) Under section 642(h)(2), excess deductions of the estate of 
$7,300 will be allowed as a deduction to A to the extent of $3,650 for 
the calendar year 1954 and to the trust to the extent of $3,650 for the 
taxable year ending August 31, 1955. The deduction of $7,300 for 
administrative expenses and corpus commissions is the only amount which 
was not taken into account in determining the net operating loss of the 
estate ($9,800 of such expenses less $2,500 taken into account).
    (d) Under section 642(h)(1), there will be allowable to A a capital 
loss carryover of $2,500 for his taxable year 1954 and for his next 4 
taxable years in accordance with paragraph (a) of Sec. 1.1212-1. There 
will be allowable to the trust a similar capital loss carryover of 
$2,500 for its taxable year ending August 31, 1955, and its next 4 
taxable years (but see paragraph (b) of Sec. 1.643(a)-3), (for taxable 
years beginning after December 31, 1963, net capital losses may be 
carried over indefinitely by beneficiaries other than corporations, in 
accordance with Sec. 1.642(h)-1 and paragraph (b) of Sec. 1.1212-1.)
    (e) The carryovers and excess deductions are not allowable directly 
to B, the trust beneficiary, but to the extent the distributable net 
income of the trust is reduced by the carryovers and excess deductions B 
may receive indirect benefit.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6828, 30 FR 
7806, June 17, 1965]



Sec. 1.642(i)-1  Certain distributions by cemetery perpetual care funds.

    (a) In general. Section 642 (i) provides that amounts distributed 
during taxable years ending after December 31, 1963, by a cemetery 
perpetual care fund trust for the care and maintenance of gravesites 
shall be treated as distributions solely for purposes of sections 651

[[Page 51]]

and 661. The deduction for such a distribution is allowable only if the 
fund is taxable as a trust. In addition, the fund must have been created 
pursuant to local law by a taxable cemetery corporation (as defined in 
Sec. 1.642 (i)-2 (a)) expressly for the care and maintenance of cemetery 
property. A care fund will be treated as having been created by a 
taxable cemetery corporation (``cemetery'') if the distributee cemetery 
is taxable, even though the care fund was created by the distributee 
cemetery in a year that it was tax-exempt or by a predecessor of such 
distributee cemetery which was tax-exempt in the year the fund was 
established. The deduction is the amount of the distributions during the 
fund's taxable year to the cemetery corporation for such care and 
maintenance that would be otherwise allowable under section 651 or 661, 
but in no event is to exceed the limitations described in paragraphs (b) 
and (c) of this section. The provisions of this paragraph shall not have 
the effect of extending the period of limitations under section 6511.
    (b) Limitation on amount of deduction. The deduction in any taxable 
year may not exceed the product of $5 multiplied by the aggregate number 
of gravesites sold by the cemetery corporation before the beginning of 
the taxable year of the trust. In general, the aggregate number of 
gravesites sold shall be the aggregate number of interment rights sold 
by the cemetery corporation (including gravesites sold by the cemetery 
before a care fund trust law was enacted). In addition, the number of 
gravesites sold shall include gravesites used to make welfare burials. 
Welfare burials and pre-trust fund law gravesites shall be included only 
to the extent that the cemetery cares for and maintain such gravesites. 
For purposes of this section, a gravesite is sold as of the date on 
which the purchaser acquires interment rights enforceable under local 
law. The aggregate number of gravesites includes only those gravesites 
with respect to which the fund or taxable cemetery corporation has an 
obligation for care and maintenance.
    (c) Requirements for deductibility of distributions for care and 
maintenance--(1) Obligation for care and maintenance. A deduction is 
allowed only for distributions for the care and maintenance of 
gravesites with respect to which the fund or taxable cemetery 
corporation has an obligation for care and maintenance. Such obligation 
may be established by the trust instrument, by local law, or by the 
cemetery's practice of caring for and maintaining gravesites, such as 
welfare burial plots or gravesites sold before the enactment of a care 
fund trust law.
    (2) Distribution actually used for care and maintenance. The amount 
of a deduction otherwise allowable for care fund distributions in any 
taxable year shall not exceed the portion of such distributions expended 
by the distributee cemetery corporation for the care and maintenance of 
gravesites before the end of the fund's taxable year following the 
taxable year in which it makes the distributions. A 6-month extension of 
time for filing the trust's return may be obtained upon request under 
section 6081. The failure of a cemetery to expend the care fund's 
distributions within a reasonable time before the due date for filing 
the return will be considered reasonable grounds for granting a 6-month 
extension of time for section 6081. For purposes of this paragraph, any 
amount expended by the care fund directly for the care and maintenance 
of gravesites shall be treated as an additional care fund distribution 
which is expended on the day of distribution by the cemetery 
corporation. The fund shall be allowed a deduction for such direct 
expenditure in the fund's taxable year during which the expenditure is 
made.
    (3) Example. The application of paragraph (c)(2) of this section is 
illustrated by the following example:

    A, a calendar-year perpetual care fund trust, meeting the 
requirements of section 642 (i), makes a $10,000 distribution on 
December 1, 1978 to X, a taxable cemetery corporation operating on a May 
31 fiscal year. From this $10,000 distribution, the cemetery makes the 
following expenditures for the care and maintenance of gravesites: 
$2,000 on December 20, 1978; $4,000 on June 1, 1979; $2,000 on October 
1, 1979; and $1,000 on April 1, 1980. In addition, as authorized by the 
trust instrument, A itself makes a direct $1,000 payment to a contractor 
on September 1, 1979 for qualifying care and maintenance

[[Page 52]]

work performed. As a result of these transactions, A will be allowed an 
$8,000 deduction for its 1978 taxable year attributable to the 
cemetery's expenditures, and a $1,000 deduction for its 1979 taxable 
year attributable to the fund's direct payment. A will not be allowed a 
deduction for its 1978 taxable year for the cemetery's expenditure of 
either the $1,000 expended on April 1, 1980 or the remaining unspent 
portion of the original $10,000 distribution. The trustee may request a 
6-month extension in order to allow the fund until October 15, 1979 to 
file its return for 1978.

    (d) Certified statement made by cemetery officials to fund trustees. 
A trustee of a cemetery perpetual care fund shall not be held personally 
liable for civil or criminal penalties resulting from false statements 
on the trust's tax return to the extent that such false statements 
resulted from the trustee's reliance on a certified statement made by 
the cemetery specifying the number of interments sold by the cemetery or 
the amount of the cemetery's expenditures for care and maintenance. The 
statement must indicate the basis upon which the cemetery determined 
what portion of its expenditures were made for the care and maintenance 
of gravesites. The statement must be certified by an officer or employee 
of the cemetery who has the responsibility to make or account for 
expenditures for care and maintenance. A copy of this statement shall be 
retained by the trustee along with the trust's return and shall be made 
available for inspection upon request by the Secretary. This paragraph 
does not relieve the care fund trust of its liability to pay the proper 
amount of tax due and to maintain adequate records to substantiate each 
of its deductions, including the deduction provided in section 642(i) 
and this section.

[T.D. 7651, 44 FR 61596, Oct. 26, 1979]



Sec. 1.642(i)-2  Definitions.

    (a) Taxable cemetery corporation. For purposes of section 642(i) and 
this section, the meaning of the term taxable cemetery corporation is 
limited to a corporation (within the meaning of section 7701(a)(3)) 
engaged in the business of owning and operating a cemetery that either 
(1) is not exempt from Federal tax, or (2) is subject to tax under 
section 511 with respect to its cemetery activities.
    (b) Pursuant to local law. A cemetery perpetual care fund is created 
pursuant to local law if:
    (1) The governing law of the relevant jurisdiction (State, district, 
county, parish, etc.) requires or expressly permits the creation of such 
a fund, or
    (2) The legally enforceable bylaws or contracts of a taxable 
cemetery corporation require a perpetual care fund.
    (c) Gravesite. A gravesite is any type of interment right that has 
been sold by a cemetery, including, but not limited to, a burial lot, 
mausoleum, lawn crypt, niche, or scattering ground. For purposes of 
Sec. 1.642 (i)-1, the term gravesites includes only those gravesites 
with respect to which the care fund or cemetery has an obligation for 
care and maintenance within the meaning of Sec. 1.642 (i)-1(c)(1).
    (d) Care and maintenance. For purposes of section 642(i) and this 
section, the term care and maintenance of gravesite shall be generally 
defined in accordance with the definition of such term under the local 
law pursuant to which the cemetery perpetual care fund is created. If 
the applicable local law contains no definition, care and maintenance of 
gravesites may include the upkeep, repair and preservation of those 
portions of cemetery property in which gravesites (as defined in 
paragraph (c) of this section) have been sold; including gardening, road 
maintenance, water line and drain repair and other activities reasonably 
necessary to the preservation of cemetery property. The costs for care 
and maintenance include, but are not limited to, expenditures for the 
maintenance, repair and replacement of machinery, tools, and equipment, 
compensation of employees performing such work, insurance premiums, 
reasonable payments for employees' pension and other benefit plans, and 
the costs of maintaining necessary records of lot ownership, transfers 
and burials. However, if some of the expenditures of the cemetery 
corporation, such as officers' salaries, are for both care and 
maintenance and for other purposes, the expenditures must be properly 
allocated between care and maintenance of gravesites and the other 
purposes. Only

[[Page 53]]

those expenditures that are properly allocable to those portions of 
cemetery property in which gravesites have been sold qualify as 
expenditures for care and maintenance of gravesites.

[T.D. 7651, 44 FR 61596, Oct. 26, 1979]



Sec. 1.643(a)-0   Distributable net income; deduction for distributions; in general.

    The term distributable net income has no application except in the 
taxation of estates and trusts and their beneficiaries. It limits the 
deductions allowable to estates and trusts for amounts paid, credited, 
or required to be distributed to beneficiaries and is used to determine 
how much of an amount paid, credited, or required to be distributed to a 
beneficiary will be includible in his gross income. It is also used to 
determine the character of distributions to the beneficiaries. 
Distributable net income means for any taxable year, the taxable income 
(as defined in section 63) of the estate or trust, computed with the 
modifications set forth in Secs. 1.643(a)-1 through 1.643(a)-7.



Sec. 1.643(a)-1   Deduction for distributions.

    The deduction allowable to a trust under section 651 and to an 
estate or trust under section 661 for amounts paid, credited, or 
required to be distributed to beneficiaries is not allowed in the 
computation of distributable net income.



Sec. 1.643(a)-2   Deduction for personal exemption.

    The deduction for personal exemption under section 642(b) is not 
allowed in the computation of distributable net income.



Sec. 1.643(a)-3   Capital gains and losses.

    (a) Except as provided in Sec. 1.643(a)-6, gains from the sale or 
exchange of capital assets are ordinarily excluded from distributable 
net income, and are not ordinarily considered as paid, credited, or 
required to be distributed to any beneficiary unless they are:
    (1) Allocated to income under the terms of the governing instrument 
or local law by the fiduciary on its books or by notice to the 
beneficiary,
    (2) Allocated to corpus and actually distributed to beneficiaries 
during the taxable year, or
    (3) Utilized (pursuant to the terms of the governing instrument or 
the practice followed by the fiduciary) in determining the amount which 
is distributed or required to be distributed.

However, if capital gains are paid, permanently set aside, or to be used 
for the purposes specified in section 642(c), so that a charitable 
deduction is allowed under that section in respect of the gains, they 
must be included in the computation of distributable net income.
    (b) Losses from the sale or exchange of capital assets are excluded 
in computing distributable net income except to the extent that they 
enter into the determination of any capital gains that are paid, 
credited, or required to be distributed to any beneficiary during the 
taxable year (but see Sec. 1.642(h)-1 with respect to capital loss 
carryovers in the year of final termination of an estate or trust).
    (c) The deduction under section 1202 (relating to capital gains) is 
taken into account in computing distributable net income to the extent 
that it is allocable to capital gains which are paid, permanently set 
aside, or to be used for the purposes specified in section 642(c). See 
the regulations under section 642(c) to determine the extent to which 
the amount so paid, permanently set aside, or to be used consists of 
capital gains. The deduction for capital gains provided in section 1202 
insofar as it is allocable to the remainder of the capital gains is not 
taken into account.
    (d) The application of this section may be illustrated by the 
following examples:

    Example 1. A trust is created to pay the income to A for life, with 
a discretionary power in the trustee to invade principal for A's 
benefit. In the taxable year, $10,000 is realized from the sale of 
securities at a profit, and $10,000 in excess of income is distributed 
to A. The capital gain is not allocated to A by the trustee. During the 
taxable year the trustee received and paid out $5,000 of dividends. No 
other cash was received or on hand during the taxable year. The capital 
gain will not ordinarily be included in distributable net income. 
However, if the trustee follows a regular practice of distributing the

[[Page 54]]

exact net proceeds of the sale of trust property, capital gains will be 
included in distributable net income.
    Example 2. The result in example 1 would have been the same if the 
trustee had been directed to pay an annuity of $15,000 a year to A 
(instead of being directed to pay the income to A with a discretionary 
power to distribute principal).
    Example 3. The trustee of a trust containing Blackacre and other 
property is directed to hold Blackacre for ten years, and then sell it 
and distribute its proceeds to A. Any capital gain realized from the 
sale of Blackacre will be included in distributable net income.
    Example 4. A trust instrument directs that the income shall be paid 
to A, and that the principal shall be distributed to A when he reaches 
age 35. All capital gains realized in the year of termination will be 
included in distributable net income. (See Sec. 1.641(b)-3 for the 
determination of the year of final termination and the taxability of 
capital gains realized after the terminating event and before final 
distribution.)
    Example 5. If in example 4 the trustee had been directed to 
distribute half of the principal to A when he reached 35, the capital 
gain would be included in distributable net income (and in the 
distribution to A) to the extent the capital gain is allocable to A 
under the governing instrument and local law. Thus, if the trust assets 
consisted entirely of 100 shares of corporation M stock and the trustee 
sold half the shares and distributed the proceeds to A, the entire 
capital gain would normally be considered as allocated to A. On the 
other hand, if the trustee sold all the shares and distributed half the 
proceeds to A, half the capital gain would be considered as allocable to 
A.
    Example 6. If in example 4 the trustee had been directed to pay 
$10,000 to B before making distribution to A, no portion of the capital 
gains would be allocable to B since the distribution to B is a gift of a 
specific sum of money within the meaning of section 663(a)(1).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
731, Jan. 17, 1969; T.D. 7357, 40 FR 23742, June 2, 1975]



Sec. 1.643(a)-4   Extraordinary dividends and taxable stock dividends.

    In the case solely of a trust which qualifies under subpart B 
(section 651 and following) as a ``simple trust,'' there are excluded 
from distributable net income extraordinary dividends (whether paid in 
cash or in kind) or taxable stock dividends which are not distributed or 
credited to a beneficiary because the fiduciary in good faith determines 
that under the terms of the governing instrument and applicable local 
law such dividends are allocable to corpus. See section 665(e), 
paragraph (b) of Sec. 1.665(e)-1, and paragraph (b) of Sec. 1.665(e)-1A 
for the treatment of such dividends upon subsequent distribution.

[T.D. 7204, 37 FR 17134, Aug. 25, 1972]



Sec. 1.643(a)-5   Tax-exempt interest.

    (a) There is included in distributable net income any tax-exempt 
interest excluded from gross income under section 103, reduced by 
disbursements allocable to such interest which would have been 
deductible under section 212 but for the provisions of section 265 
(relating to disallowance of deductions allocable to tax-exempt income).
    (b) If the estate or trust is allowed a charitable contributions 
deduction under section 642(c), the amounts specified in paragraph (a) 
of this section and Sec. 1.643(a)-6 are reduced by the portion deemed to 
be included in income paid, permanently set aside, or to be used for the 
purposes specified in section 642(c). If the governing instrument 
specifically provides as to the source out of which amounts are paid, 
permanently set aside, or to be used for such charitable purposes, the 
specific provisions control. In the absence of specific provisions in 
the governing instrument, an amount to which section 642(c) applies is 
deemed to consist of the same proportion of each class of the items of 
income of the estate or trust as the total of each class bears to the 
total of all classes. For illustrations showing the determination of the 
character of an amount deductible under section 642(c), see examples 1 
and 2 of Sec. 1.662(b)-2 and paragraph (e) of Sec. 1.662(c)-4.



Sec. 1.643(a)-6   Income of foreign trust.

    (a) Distributable net income of a foreign trust. In the case of a 
foreign trust (see section 7701(a)(31)), the determination of 
distributable net income is subject to the following rules:
    (1) There is included in distributable net income the amounts of 
gross income from sources without the United States, reduced by 
disbursements allocable to such foreign income which would have been 
deductible but for the provisions of section 265 (relating to 
disallowance of deductions allocable to tax exempt income). See 
paragraph (b)

[[Page 55]]

of Sec. 1.643(a)-5 for rules applicable when an estate or trust is 
allowed a charitable contributions deduction under section 642(c).
    (2) In the case of a distribution made by a trust before January 1, 
1963, for purposes of determining the distributable net income of the 
trust for the taxable year in which the distribution is made, or for any 
prior taxable year;
    (i) Gross income from sources within the United States is determined 
by taking into account the provisions of section 894 (relating to income 
exempt under treaty); and
    (ii) Distributable net income is determined by taking into account 
the provisions of section 643(a)(3) (relating to exclusion of certain 
gains from the sale or exchange of capital assets).
    (3) In the case of a distribution made by a trust after December 31, 
1962, for purposes of determining the distributable net income of the 
trust for any taxable year, whether ending before January 1, 1963, or 
after December 31, 1962;
    (i) Gross income (for the entire foreign trust) from sources within 
the United States is determined without regard to the provisions of 
section 894 (relating to income exempt under treaty);
    (ii) In respect of a foreign trust created by a U.S. person (whether 
such trust constitutes the whole or only a portion of the entire foreign 
trust) (see section 643(d) and Sec. 1.643(d)-1), there shall be included 
in gross income gains from the sale or exchange of capital assets 
reduced by losses from such sales or exchanges to the extent such losses 
do not exceed gains from such sales or exchanges, and the deduction 
under section 1202 (relating to deduction for capital gains) shall not 
be taken into account; and
    (iii) In respect of a foreign trust created by a person other than a 
U.S. person (whether such trust constitutes the whole or only a portion 
of the entire foreign trust) (see section 643(d) and Sec. 1.643(d)-1), 
distributable net income is determined by taking into account all of the 
provisions of section 643 except section 643(a)(6)(C) (relating to gains 
from the sale or exchange of capital assets by a foreign trust created 
by a U.S. person).
    (b) Examples. The application of this section, showing the 
computation of distributable net income for one of the taxable years for 
which such a computation must be made, may be illustrated by the 
following examples:

    Example 1. (1) A trust is created in 1952 under the laws of Country 
X by the transfer to a trustee in Country X of money and property by a 
U.S. person. The entire trust constitutes a foreign trust created by a 
U.S. person. The income from the trust corpus is to be accumulated until 
the beneficiary, a resident citizen of the United States who was born in 
1944, reaches the age of 21 years, and upon his reaching that age, the 
corpus and accumulated income are to be distributed to him. The trust 
instrument provides that capital gains are to be allocated to corpus and 
are not to be paid, credited, or required to be distributed to any 
beneficiary during the taxable year or paid, permanently set aside, or 
to be used for the purposes specified in section 642(c). Under the terms 
of a tax convention between the United States and Country X, interest 
income received by the trust from U.S. sources is exempt from U.S. 
taxation. In 1965 the corpus and accumulated income are distributed to 
the beneficiary. During the taxable year 1964, the trust has the 
following items of income, loss, and expense:

Interest on bonds of a U.S. corporation......................    $10,000
Net long-term capital gain from U.S. sources.................     30,000
Gross income from investments in Country X...................     40,000
Net short-term capital loss from U.S. sources................      5,000
Expenses allocable to gross income from investments in                  
 Country X...................................................      5,000
                                                                        

    (2) The distributable net income for the taxable year 1964 of the 
foreign trust created by a U.S. person, determined under section 643(a), 
is $70,000, computed as follows:

Interest on bonds of a U.S. corporation......................    $10,000
Gross income from investments in Country X...................     40,000
Net long-term capital gain from U.S. sources......    $30,000           
Less: Net short-term capital loss from U.S.                             
 sources..........................................      5,000           
                                                   ===========          
Excess of net long-term capital gain over net short-term                
 capital loss................................................     25,000
                                                   ------------         
    Total....................................................     75,000
Less: Expenses allocable to income from investments in                  
 Country X...................................................      5,000
                                                   ------------         
    Distributable net income.................................     70,000
                                                                        

    (3) In determining the distributable net income of $70,000, the 
taxable income of the trust is computed with the following 
modifications: No deduction is allowed for the personal exemption of the 
trust (section 643(a)(2)); the interest received on bonds of a U.S. 
corporation is included in the trust

[[Page 56]]

gross income despite the fact that such interest is exempt from U.S. tax 
under the provisions of the tax treaty between Country X and the United 
States (section 643(a)(6) (see H. Con. Res. (B)); the excess of net 
long-term capital gain over net short-term capital loss allocable to 
corpus is included in distributable net income, but such excess is not 
subject to the deduction under section 1202 (section 643(a)(6)(C)); and 
the amount representing gross income from investments in Country X is 
included, but such amount is reduced by the amount of the disbursements 
allocable to such income (section 643(a)(6)(A)).
    Example 2. (1) The facts are the same as in example 1 except that 
money or property has also been transferred to the trust by a person 
other than a U.S. person and, pursuant to the provisions of 
Sec. 1.643(d)-1, during 1964 only 60 percent of the entire trust 
constitutes a foreign trust created by a U.S. person.
    (2) The distributable net income for the taxable year 1964 of the 
foreign trust created by a U.S. person, determined under section 643(a), 
is $42,000 computed as follows:

Interest on bonds of a U.S. corporation (60 percent of                  
 $10,000).....................................................    $6,000
Gross income from investments in Country X (60 percent of               
 $40,000).....................................................    24,000
Net long-term capital gain from U.S. sources (60                        
 percent of $30,000)................................   $18,000          
Less: Net short-term capital loss from U.S. sources                     
 (60 percent of $5,000).............................     3,000          
                                                     ----------         
                                                                  15,000
                                                               ---------
    Total...........................................              45,000
Less: Expenses allocable to income from investments in Country          
 X (60 percent of $5,000).....................................     3,000
                                                     -----------        
    Distributable net income..................................    42,000
                                                                        

    (3) The distributable net income for the taxable year 1964 of the 
portion of the entire foreign trust which does not constitute a foreign 
trust created by a U.S. person, determined under section 643(a), is 
$18,000, computed as follows:

Interest on bonds of a U.S. corporation (40 percent of                  
 $10,000).....................................................    $4,000
Gross income from investments in Country X (40 percent of               
 $40,000).....................................................    16,000
                                                               ---------
    Total.....................................................    20,000
Less: Expenses allocable to income from investments in Country          
 X (40 percent of $5,000).....................................     2,000
                                                               ---------
    Distributable net income..................................    18,000
                                                                        

    (4) The distributable net income of the entire foreign trust for the 
taxable year 1964 is $60,000, computed as follows:

Distributable net income of the foreign trust created by a              
 U.S. person.................................................    $42,000
Distributable net income of that portion of the entire                  
 foreign trust which does not constitute a foreign trust                
 created by a U.S. person....................................     18,000
                                                              ----------
  Distributable net income of the entire foreign trust.......     60,000
                                                                        

It should be noted that the difference between the $70,000 distributable 
net income of the foreign trust in example 1 and the $60,000 
distributable net income of the entire foreign trust in this example is 
due to the $10,000 (40 percent of $25,000) net capital gain (capital 
gain net income for taxable years beginning after December 31, 1976) 
which under section 643(a)(3) is excluded from the distributable net 
income of that portion of the foreign trust in example 2 which does not 
constitute a foreign trust created by a U.S. person.

[T.D. 6989, 34 FR 731, Jan. 17, 1969, as amended by T.D. 7728, 45 FR 
72650, Nov. 3, 1980]



Sec. 1.643(a)-7   Dividends.

    Dividends excluded from gross income under section 116 (relating to 
partial exclusion of dividends received) are included in distributable 
net income. For this purpose, adjustments similar to those required by 
Sec. 1.643(a)-5 with respect to expenses allocable to tax-exempt income 
and to income included in amounts paid or set aside for charitable 
purposes are not made. See the regulations under section 642(c).

[T.D. 7357, 40 FR 23742, June 2, 1975]



Sec. 1.643(b)-1   Definition of ``income''.

    For purposes of subparts A through D, part I, subchapter J, chapter 
1 of the Code, the term income when not preceded by the words 
``taxable'', ``distributable net'', ``undistributed net'', or ``gross'', 
means the amount of income of an estate or trust for the taxable year 
determined under the terms of its governing instrument and applicable 
local law. Trust provisions which depart fundamentally from concepts of 
local law in the determination of what constitutes income are not 
recognized for this purpose. For example, if a trust instrument directs 
that all the trust income shall be paid to A, but defines ordinary 
dividends and interest as corpus, the trust will not be considered one 
which under its governing instrument is required to distribute all its 
income currently for purposes of section 642(b) (relating to the 
personal exemption) and section 651 (relating to ``simple'' trusts).

[[Page 57]]



Sec. 1.643(b)-2   Dividends allocated to corpus.

    Extraordinary dividends or taxable stock dividends which the 
fiduciary, acting in good faith, determines to be allocable to corpus 
under the terms of the governing instrument and applicable local law are 
not considered ``income'' for purposes of subpart A, B, C, or D, part I, 
subchapter J, chapter 1 of the Code. See section 643(a)(4), 
Sec. 1.643(a)-4, Sec. 1.643(d)-2, section 665(e), paragraph (b) of 
Sec. 1.665(e)-1, and paragraph (b) of Sec. 1.665(e)-1A for the treatment 
of such items in the computation of distributable net income.

[T.D. 7204, 37 FR 17134, Aug. 25, 1972]



Sec. 1.643(c)-1   Definition of ``beneficiary''.

    An heir, legatee, or devisee (including an estate or trust) is a 
beneficiary. A trust created under a decedent's will is a beneficiary of 
the decedent's estate. The following persons are treated as 
beneficiaries:
    (a) Any person with respect to an amount used to discharge or 
satisfy that person's legal obligation as that term is used in 
Sec. 1.662(a)-4.
    (b) The grantor of a trust with respect to an amount applied or 
distributed for the support of a dependent under the circumstances 
specified in section 677(b) out of corpus or out of other than income 
for the taxable year of the trust.
    (c) The trustee or cotrustee of a trust with respect to an amount 
applied or distributed for the support of a dependent under the 
circumstances specified in section 678(c) out of corpus or out of other 
than income for the taxable year of the trust.



Sec. 1.643(d)-1   Definition of ``foreign trust created by a United States person''.

    (a) In general. For the purpose of part I, subchapter J, chapter 1 
of the Internal Revenue Code, the term foreign trust created by a United 
States person means that portion of a foreign trust (as defined in 
section 7701(a)(31)) attributable to money or property (including all 
accumulated earnings, profits, or gains attributable to such money or 
property) of a U.S. person (as defined in section 7701(a)(30)) 
transferred directly or indirectly, or under the will of a decedent who 
at the date of his death was a U.S. citizen or resident, to the foreign 
trust. A foreign trust created by a person who is not a U.S. person, to 
which a U.S. person transfers his money or property, is a foreign trust 
created by a U.S. person to the extent that the fair market value of the 
entire foreign trust is attributable to money or property of the U.S. 
person transferred to the foreign trust. The transfer of money or 
property to the foreign trust may be made either directly or indirectly 
by a U.S. person. Transfers of money or property to a foreign trust do 
not include transfers of money or property pursuant to a sale or 
exchange which is made for a full and adequate consideration. Transfers 
to which section 643(d) and this section apply are transfers of money or 
property which establish or increase the corpus of a foreign trust. The 
rules set forth in this section with respect to transfers by a U.S. 
person to a foreign trust also are applicable with respect to transfers 
under the will of a decedent who at the date of his death was a U.S. 
citizen or resident. For provisions relating to the information returns 
which are required to be filed with respect to the creation of or 
transfers to foreign trusts, see section 6048 and Sec. 16.3-1 of this 
chapter (Temporary Regulations under the Revenue Act of 1962).
    (b) Determination of a foreign trust created by a U.S. person--(1) 
Transfers of money or property only by a U.S. person. If all the items 
of money or property constituting the corpus of a foreign trust are 
transferred to the trust by a U.S. person, the entire foreign trust is a 
foreign trust created by a U.S. person.
    (2) Transfers of money or property by both a U.S. person and a 
person other than a U.S. person; transfers required to be treated as 
separate funds. Where there are transfers of money or property by both a 
U.S. person and a person other than a U.S. person to a foreign trust, 
and it is necessary, either by reason of the provisions of the governing 
instrument of the trust or by reason of some other requirement such as 
local law, that the trustee treat the entire foreign trust as composed 
of two separate funds, one consisting of the money or

[[Page 58]]

property (including all accumulated earnings, profits, or gains 
attributable to such money or property) transferred by the U.S. person 
and the other consisting of the money or property (including all 
accumulated earnings, profits, or gains attributable to such money or 
property) transferred by the person other than the U.S. person, the 
foreign trust created by a U.S. person shall be the fund consisting of 
the money or property transferred by the U.S. person. See example 1 in 
paragraph (c) of this section.
    (3) Transfers of money or property by both a U.S. person and a 
person other than a U.S. person; transfers not required to be treated as 
separate funds. Where the corpus of a foreign trust consists of money or 
property transferred to the trust (simultaneously or at different times) 
by a U.S. person and by a person who is not a U.S. person, the foreign 
trust created by a U.S. person within the meaning of section 643(d) is 
that portion of the entire foreign trust which, immediately after any 
transfer of money or property to the trust, the fair market value of 
money or property (including all accumulated earnings, profits, or gains 
attributable to such money or property) transferred to the foreign trust 
by the U.S. person bears to the fair market value of the corpus 
(including all accumulated earnings, profits, or gains attributable to 
the corpus) of the entire foreign trust.
    (c) Examples. The provisions of paragraph (b) of this section may be 
illustrated by the following examples. Example 1 illustrates the 
application of paragraph (b)(2) of this section. Example (2) illustrates 
the application of paragraph (b)(3) of this section in a case where 
there is no provision in the governing instrument of the trust or 
elsewhere which would require the trustee to treat the corpus of the 
trust as composed of more than one fund.

    Example 1. On January 1, 1964, the date of the creation of a foreign 
trust, a U.S. person transfers to it stock of a U.S. corporation with a 
fair market value of $50,000. On the same day, a person other than a 
U.S. person transfers to the trust Country X bonds with a fair market 
value of $25,000. The governing instrument of the trust provides that 
the income from the stock of the U.S. corporation is to be accumulated 
until A, a U.S. beneficiary, reaches the age of 21 years, and upon his 
reaching that age, the stock and income accumulated thereon are to be 
distributed to him. The governing instrument of the trust further 
provides that the income from the Country X bonds is to be accumulated 
until B, a U.S. beneficiary, reaches the age of 21 years, and upon his 
reaching that age, the bonds and income accumulated thereon are to be 
distributed to him. To comply with the provisions of the governing 
instrument of the trust that the income from the stock of the U.S. 
corporation be accumulated and distributed to A and that the income from 
the Country X bonds be accumulated and distributed to B, it is necessary 
that the trustee treat the transfers as two separate funds. The fund 
consisting of the stock of the U.S. corporation is a foreign trust 
created by a U.S. person.
    Example 2. On January 1, 1964, the date of the creation of a foreign 
trust, a U.S. person transfers to it property having a fair market value 
of $60,000 and a person other than a U.S. person transfers to it 
property having a fair market value of $40,000. Immediately after these 
transfers, the foreign trust created by a U.S. person is 60 percent of 
the entire foreign trust, determined as follows:
$60,000 (Value of property transferred by U.S. person)/$100,000 (Value 
of entire property transferred to trust)=60 percent
The undistributed net income for the calendar years 1964 and 1965 is 
$20,000 which increases the value of the entire foreign trust to 
$120,000 ($100,000 plus $20,000). Accordingly, as of December 31, 1965, 
the portion of the foreign trust created by the U.S. person is $72,000 
(60 percent of $120,000). On January 1, 1966, the U.S. person transfers 
property having a fair market value of $40,000 increasing the value of 
the entire foreign trust to $160,000 ($120,000 plus $40,000) and 
increasing the value of the portion of the foreign trust created by the 
U.S. person to $112,000 ($72,000 plus $40,000). Immediately, after this 
transfer, the foreign trust created by the U.S. person is 70 percent of 
the entire foreign trust, determined as follows:
$112,000 (Value of property transferred by U.S. person)/$160,000 (Value 
of entire property transferred to the trust)=70 percent
[T.D. 6989, 34 FR 732, Jan. 17, 1969]



Sec. 1.643(d)-2  Illustration of the provisions of section 643.

    (a) The provisions of section 643 may be illustrated by the 
following example:

    Example. (1) Under the terms of the trust instrument, the income of 
a trust is required to be currently distributed to W during her life. 
Capital gains are allocable to corpus and

[[Page 59]]

all expenses are charges against corpus. During the taxable year the 
trust has the following items of income and expenses:

Dividends from domestic corporations.........................    $30,000
Extraordinary dividends allocated to corpus by the trustee in           
 good faith..................................................     20,000
Taxable interest.............................................     10,000
Tax-exempt interest..........................................     10,000
Long-term capital gains......................................     10,000
Trustee's commissions and miscellaneous expenses allocable to           
 corpus......................................................      5,000
                                                                        

    (2) The ``income'' of the trust determined under section 643(b) 
which is currently distributable to W is $50,000, consisting of 
dividends of $30,000, taxable interest of $10,000, and tax-exempt 
interest of $10,000. The trustee's commissions and miscellaneous 
expenses allocable to tax-exempt interest amount to $1,000 (10,000/
50,000 x  $5,000).
    (3) The ``distributable net income'' determined under section 643(a) 
amounts to $45,000, computed as follows:

Dividends from domestic corporations.........................    $30,000
Taxable interest.............................................     10,000
Nontaxable interest...............................    $10,000           
Less: Expenses allocable thereto..................      1,000           
                                                   -----------          
                                                                   9,000
                                                   ------------         
    Total....................................................     49,000
Less: Expenses ($5,000 less $1,000 allocable to tax-exempt              
 interest)...................................................      4,000
                                                   ------------         
    Distributable net income.................................     45,000
                                                                        

In determining the distributable net income of $45,000, the taxable 
income of the trust is computed with the following modifications: No 
deductions are allowed for distributions to W and for personal exemption 
of the trust (section 643(a) (1) and (2)); capital gains allocable to 
corpus are excluded and the deduction allowable under section 1202 is 
not taken into account (section 643(a)(3)): the extraordinary dividends 
allocated to corpus by the trustee in good faith are excluded (sections 
643(a)(4)); and the tax- exempt interest (as adjusted for expenses) and 
the dividend exclusion of $50 are included) section 643(a) (5) and (7)).

    (b) See paragraph (c) of the example in Sec. 1.661(c)-2 for the 
computation of distributable net income where there is a charitable 
contributions deduction.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960. Redesignated, T.D. 6989, 34 FR 
732, Jan. 1, 1969]

    Pooled Income Fund Actuarial Tables Applicable Before May 1, 1989



Sec. 1.642(c)-6A  Valuation of charitable remainder interests for which the valuation date is before May 1, 1989.

    (a) Valuation of charitable remainder interests for which the 
valuation date is before January 1, 1952. There was no provision for the 
qualification of pooled income funds under section 642 until 1969. See 
Sec. 20.2031-7A(a) of this chapter (Estate Tax Regulations) for the 
determination of the present value of a charitable remainder interest 
created before January 1, 1952.
    (b) Valuation of charitable remainder interests for which the 
valuation date is after December 31, 1951, and before January 1, 1971. 
No charitable deduction is allowable for a transfer to a pooled income 
fund for which the valuation date is after the effective dates of the 
Tax Reform Act of 1969 unless the pooled income fund meets the 
requirements of section 642(c)(5). See Sec. 20.2031-7A(b) of this 
chapter (Estate Tax Regulations) for the determination of the present 
value of a charitable remainder interest for which the valuation date is 
after December 31, 1951, and before January 1, 1971.
    (c) Present value of remainder interest in the case of transfers to 
pooled income funds for which the valuation date is after December 31, 
1970, and before December 1, 1983. For the determination of the present 
value of a remainder interest in property transferred to a pooled income 
fund for which the valuation date is after December 31, 1970, and before 
December 1, 1983, see Sec. 20.2031-7A(c) of this chapter (Estate Tax 
Regulations) and former Sec. 1.642(c)-6(e) (as contained in the 26 CFR 
part 1 edition revised as of April 1, 1994).
    (d) Present value of remainder interest dependent on the termination 
of one life in the case of transfers to pooled income funds made after 
November 30, 1983, for which the valuation date is before May 1, 1989--
(1) In general. For transfers to

[[Page 60]]

pooled income funds made after November 30, 1983, for which the 
valuation date is before May 1, 1989, the present value of the remainder 
interest at the time of the transfer of property to the fund is 
determined by computing the present value (at the time of the transfer) 
of the life income interest in the transferred property (as determined 
under paragraph (d)(2) of this section) and subtracting that value from 
the fair market value of the transferred property on the valuation date. 
The present value of a remainder interest that is dependent on the 
termination of the life of one individual is computed by use of Table G 
in paragraph (d)(4) of this section. For purposes of the computation 
under this section, the age of an individual is to be taken as the age 
of the individual at the individual's nearest birthday.
    (2) Present value of life income interest. The present value of the 
life income interest in property transferred to a pooled income fund 
shall be computed on the basis of:
    (i) Life contingencies determined from the values of lx that are set 
forth in Table LN of Sec. 20.2031-7A(d)(6) of this chapter (Estate Tax 
Regulations); and
    (ii) Discount at a rate of interest, compounded annually, equal to 
the highest yearly rate of return of the pooled income fund for the 3 
taxable years immediately preceding its taxable year in which the 
transfer of property to the fund is made. For purposes of this paragraph 
(d)(2), the yearly rate of return of a pooled income fund is determined 
as provided in Sec. 1.642(c)-6(c) unless the highest yearly rate of 
return is deemed to be 9 percent. For purposes of this paragraph (d)(2), 
the first taxable year of a pooled income fund is considered a taxable 
year even though the taxable year consists of less than 12 months. 
However, appropriate adjustments must be made to annualize the rate of 
return earned by the fund for that period. Where it appears from the 
facts and circumstances that the highest yearly rate of return for the 3 
taxable years immediately preceding the taxable year in which the 
transfer of property is made has been purposely manipulated to be 
substantially less than the rate of return that would otherwise be 
reasonably anticipated with the purpose of obtaining an excessive 
charitable deduction, that rate of return may not be used. In that case, 
the highest yearly rate of return of the fund is determined by treating 
the fund as a pooled income fund that has been in existence for less 
than 3 preceding taxable years. If a pooled income fund has been in 
existence less than 3 taxable years immediately preceding the taxable 
year in which the transfer of property to the fund is made, the highest 
yearly rate of return is deemed to be 9 percent.
    (3) Computation of value of remainder interest. The factor which is 
used in determining the present value of the remainder interest is the 
factor under the appropriate yearly rate of return in column (2) of 
Table G opposite the number in column (1) which corresponds to the age 
of the individual upon whose life the value of the remainder interest is 
based. If the yearly rate of return is a percentage which is between 
yearly rates of return for which factors are provided in Table G, a 
linear interpolation must be made. The present value of the remainder 
interest is determined by multiplying, by the factor determined under 
this paragraph (d)(3), the fair market value on the appropriate 
valuation date. If the yearly rate of return is below 2.2 percent or 
above 14 percent, see Sec. 1.642(c)-6(b). This paragraph (d)(3) may be 
illustrated by the following example:

    Example. A, who will be 50 years old on April 15, 1985, transfers 
$100,000 to a pooled income fund on January 1, 1985, and retains a life 
income interest in such property. The highest yearly rate of return 
earned by the fund for its 3 preceding taxable years is 9.9 percent. In 
Table G the figure in column (2) opposite 50 years under 9.8 percent is 
.15653 and under 10 percent is .15257. The present value of the 
remainder interest is $15,455, computed as follows:

Factor at 9.8 percent for person aged 50......................    .15653
Factor at 10 percent for person aged 50.......................    .15257
                                                               ---------
Difference....................................................    .00396
Interpolation adjustment:                                               
                                                                        


                                                                                                                
                                                    9.9%-9.8%           x                                       
                                                ----------------  = ---------                                   
                                                       .2%            .00396                                    
                                                                                                                
x=.00198                                                                                                        


Factor at 9.8 percent for person aged 50.....................    0.15653

[[Page 61]]

                                                                        
Less:                                                                   
  Interpolation adjustment...................................     .00198
                                                              ----------
  Interpolated factor........................................     .15455
                                                              ==========
Present value of remainder interest ($100,000  x  .15455.....    $15,455
                                                                        

    (4) Actuarial tables. The following tables shall be used in the 
application of the provisions of this section.

                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  2.2%      2.4%      2.6%      2.8%      3.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .23930    .21334    .19077    .17113    .15401
1.............................................................    .22891    .20224    .17903    .15880    .14114
2.............................................................    .23297    .20610    .18265    .16218    .14429
3.............................................................    .23744    .21035    .18669    .16600    .14787
4.............................................................    .24212    .21485    .19098    .17006    .15171
5.............................................................    .24701    .21955    .19547    .17434    .15577
6.............................................................    .25207    .22442    .20015    .17880    .16001
7.............................................................    .25726    .22944    .20497    .18342    .16441
8.............................................................    .26259    .23461    .20995    .18820    .16898
9.............................................................    .26809    .23995    .21511    .19315    .17373
10............................................................    .27373    .24544    .22043    .19828    .17865
11............................................................    .27953    .25110    .22592    .20358    .18375
12............................................................    .28546    .25690    .23156    .20904    .18902
13............................................................    .29149    .26280    .23731    .21462    .19440
14............................................................    .29757    .26877    .24312    .22026    .19986
15............................................................    .30368    .27476    .24896    .22593    .20535
16............................................................    .30978    .28075    .25481    .23161    .21085
17............................................................    .31589    .28676    .26068    .23732    .21637
18............................................................    .32204    .29280    .26659    .24306    .22193
19............................................................    .32825    .29892    .27257    .24889    .22759
20............................................................    .33457    .30514    .27867    .25484    .23336
21............................................................    .34099    .31148    .28489    .26092    .23927
22............................................................    .34751    .31794    .29124    .26712    .24532
23............................................................    .35416    .32452    .29773    .27348    .25152
24............................................................    .36096    .33127    .30439    .28002    .25791
25............................................................    .36793    .33821    .31124    .28676    .26452
26............................................................    .37509    .34535    .31832    .29374    .27136
27............................................................    .38244    .35269    .32560    .30093    .27844
28............................................................    .38998    .36023    .33311    .30836    .28577
29............................................................    .39767    .36795    .34080    .31599    .29330
30............................................................    .40553    .37584    .34868    .32382    .30104
31............................................................    .41352    .38388    .35672    .33182    .30897
32............................................................    .42165    .39208    .36494    .34001    .31710
33............................................................    .42993    .40044    .37333    .34839    .32543
34............................................................    .43834    .40894    .38188    .35694    .33395
35............................................................    .44689    .41760    .39060    .36567    .34266
36............................................................    .45556    .42640    .39947    .37458    .35156
37............................................................    .46435    .43534    .40850    .38365    .36063
38............................................................    .47325    .44440    .41767    .39288    .36987
39............................................................    .48226    .45358    .42696    .40225    .37927
40............................................................    .49136    .46288    .43640    .41177    .38884
41............................................................    .50056    .47228    .44596    .42143    .39856
42............................................................    .50988    .48182    .45566    .43125    .40846
43............................................................    .51927    .49145    .46547    .44120    .41850
44............................................................    .52874    .50118    .47540    .45128    .42869
45............................................................    .53828    .51099    .48543    .46146    .43899
46............................................................    .54788    .52088    .49554    .47176    .44943
47............................................................    .55754    .53083    .50574    .48216    .45998
48............................................................    .56726    .54087    .51604    .49267    .47065
49............................................................    .57703    .55097    .52642    .50327    .48144
50............................................................    .58685    .56114    .53688    .51398    .49234
51............................................................    .59670    .57136    .54740    .52476    .50333
52............................................................    .60658    .58161    .55798    .53560    .51441
53............................................................    .61647    .59189    .56859    .54651    .52556
54............................................................    .62635    .60217    .57923    .55744    .53675
55............................................................    .63622    .61246    .58987    .56840    .54798
56............................................................    .64606    .62273    .60052    .57937    .55923
57............................................................    .65589    .63299    .61117    .59037    .57052
58............................................................    .66569    .64324    .62181    .60136    .58183
59............................................................    .67546    .65347    .63246    .61237    .59316
60............................................................    .68521    .66368    .64309    .62338    .60450
61............................................................    .69492    .67388    .65372    .63440    .61587
62............................................................    .70461    .68406    .66434    .64542    .62726
63............................................................    .71425    .69420    .67494    .65643    .63865
64............................................................    .72384    .70430    .68550    .66742    .65002
65............................................................    .73336    .71434    .69602    .67837    .66137
66............................................................    .74281    .72431    .70647    .68926    .67267
67............................................................    .75216    .73419    .71684    .70009    .68391
68............................................................    .76143    .74399    .72714    .71085    .69509
69............................................................    .77060    .75370    .73735    .72153    .70622
70............................................................    .77969    .76334    .74750    .73215    .71728
71............................................................    .78870    .77290    .75758    .74272    .72830
72............................................................    .79764    .78240    .76760    .75323    .73928
73............................................................    .80646    .79178    .77751    .76364    .75016
74............................................................    .81511    .80099    .78725    .77387    .76086
75............................................................    .82353    .80995    .79674    .78386    .77132
76............................................................    .83169    .81866    .80596    .79357    .78149
77............................................................    .83960    .82710    .81491    .80301    .79139
78............................................................    .84727    .83530    .82360    .81218    .80101
79............................................................    .85473    .84328    .83207    .82112    .81041
80............................................................    .86201    .85106    .84034    .82986    .81960
81............................................................    .86905    .85861    .84837    .83835    .82853
82............................................................    .87585    .86589    .85612    .84655    .83717
83............................................................    .88239    .87291    .86360    .85447    .84552
84............................................................    .88873    .87971    .87085    .86216    .85362
85............................................................    .89487    .88630    .87789    .86963    .86150
86............................................................    .90070    .89258    .88459    .87674    .86901
87............................................................    .90609    .89838    .89079    .88332    .87597
88............................................................    .91106    .90372    .89650    .88939    .88239
89............................................................    .91570    .90872    .90184    .89507    .88839
90............................................................    .92014    .91350    .90696    .90051    .89416
91............................................................    .92435    .91804    .91182    .90569    .89964
92............................................................    .92822    .92222    .91630    .91045    .90469
93............................................................    .93170    .92597    .92032    .91474    .90923
94............................................................    .93477    .92929    .92387    .91853    .91325
95............................................................    .93743    .93216    .92695    .92181    .91673
96............................................................    .93967    .93458    .92955    .92458    .91966
97............................................................    .94167    .93674    .93186    .92704    .92228
98............................................................    .94342    .93863    .93389    .92921    .92457
99............................................................     94508     94041    .93580    .93124    .92673
100...........................................................    .94672    .94218    .93770    .93326    .92887
101...........................................................    .94819    .94377    .93940    .93508    .93080
102...........................................................    .94979    .94550    .94125    .93704    .93288
103...........................................................    .95180    .94766    .94357    .93952    .93550
104...........................................................    .95377    .94979    .94585    .94194    .93806
105...........................................................    .95663    .95288    .94916    .94547    .94181
106...........................................................    .96101    .95762    .95425    .95091    .94760
107...........................................................    .96688    .96398    .96110    .95824    .95539
108...........................................................    .97569    .97354    .97141    .96928    .96717
109...........................................................    .98924    .98828    .98733    .98638    .98544
----------------------------------------------------------------------------------------------------------------


[[Page 62]]


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  3.2%      3.4%      3.6%      3.8%      4.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .13908    .12603    .11461    .10461    .09583
1.............................................................    .12570    .11220    .10036    .08998    .08086
2.............................................................    .12862    .11489    .10284    .09225    .08293
3.............................................................    .13198    .11802    .10576    .09496    .08544
4.............................................................    .13559    .12141    .10893    .09793    .08821
5.............................................................    .13943    .12503    .11234    .10112    .09121
6.............................................................    .14345    .12884    .11593    .10451    .09439
7.............................................................    .14763    .13280    .11968    .10805    .09773
8.............................................................    .15198    .13694    .12360    .11176    .10125
9.............................................................    .15652    .14126    .12771    .11567    .10495
10............................................................    .16123    .14576    .13200    .11975    .10883
11............................................................    .16613    .15045    .13648    .12402    .11290
12............................................................    .17119    .15531    .14113    .12847    .11715
13............................................................    .17638    .16029    .14591    .13304    .12152
14............................................................    .18164    .16535    .15076    .13769    .12597
15............................................................    .18693    .17044    .15565    .14238    .13045
16............................................................    .19224    .17554    .16055    .14707    .13494
17............................................................    .19756    .18066    .16547    .15178    .13945
18............................................................    .20294    .18584    .17044    .15655    .14401
19............................................................    .20840    .19110    .17550    .16140    .14866
20............................................................    .21399    .19650    .18069    .16639    .15344
21............................................................    .21972    .20203    .18602    .17152    .15836
22............................................................    .22559    .20771    .19151    .17680    .16344
23............................................................    .23162    .21356    .19716    .18225    .16869
24............................................................    .23784    .21960    .20301    .18791    .17414
25............................................................    .24429    .22588    .20910    .19380    .17984
26............................................................    .25098    .23240    .21545    .19996    .18581
27............................................................    .25792    .23918    .22206    .20639    .19205
28............................................................    .26512    .24623    .22894    .21310    .19858
29............................................................    .27253    .25350    .23605    .22004    .20534
30............................................................    .28016    .26100    .24341    .22724    .21236
31............................................................    .28799    .26871    .25097    .23464    .21961
32............................................................    .29603    .27664    .25877    .24230    .22710
33............................................................    .30428    .28478    .26679    .25018    .23484
34............................................................    .31273    .29314    .27504    .25830    .24280
35............................................................    .32139    .30172    .28351    .26665    .25102
36............................................................    .33024    .31050    .29220    .27523    .25948
37............................................................    .33929    .31949    .30111    .28404    .26816
38............................................................    .34851    .32867    .31022    .29305    .27707
39............................................................    .35791    .33804    .31953    .30228    .28620
40............................................................    .36749    .34759    .32904    .31172    .29555
41............................................................    .37724    .35733    .33874    .32137    .30512
42............................................................    .38717    .36727    .34866    .33124    .31493
43............................................................    .39727    .37739    .35877    .34132    .32495
44............................................................    .40752    .38768    .36906    .35159    .33518
45............................................................    .41791    .39811    .37952    .36204    .34560
46............................................................    .42844    .40871    .39014    .37267    .35621
47............................................................    .43910    .41944    .40092    .38347    .36701
48............................................................    .44990    .43034    .41188    .39446    .37801
49............................................................    .46083    .44137    .42299    .40562    .38919
50............................................................    .47189    .45256    .43427    .41695    .40056
51............................................................    .48306    .46386    .44567    .42844    .41209
52............................................................    .49432    .47528    .45721    .44006    .42378
53............................................................    .50567    .48679    .46886    .45182    .43562
54............................................................    .51708    .49838    .48060    .46367    .44756
55............................................................    .52854    .51004    .49242    .47563    .45962
56............................................................    .54004    .52175    .50430    .48766    .47177
57............................................................    .55159    .53352    .51626    .49978    .48402
58............................................................    .56316    .54533    .52827    .51196    .49636
59............................................................    .57478    .55719    .54036    .52424    .50879
60............................................................    .58643    .56910    .55250    .53658    .52131
61............................................................    .59811    .58107    .56471    .54901    .53393
62............................................................    .60982    .59307    .57697    .56150    .54662
63............................................................    .62155    .60510    .58928    .57405    .55940
64............................................................    .63327    .61714    .60161    .58664    .57222
65............................................................    .64498    .62918    .61395    .59926    .58508
66............................................................    .65666    .64120    .62628    .61188    .59796
67............................................................    .66829    .65319    .63859    .62448    .61083
68............................................................    .67986    .66512    .65086    .63706    .62370
69............................................................    .69139    .67702    .66311    .64963    .63656
70............................................................    .70286    .68888    .67533    .66218    .64942
71............................................................    .71431    .70073    .68754    .67474    .66231
72............................................................    .72572    .71255    .69974    .68730    .67520
73............................................................    .73704    .72429    .71188    .69980    .68805
74............................................................    .74819    .73586    .72384    .71214    .70075
75............................................................    .75909    .74718    .73557    .72424    .71320
76............................................................    .76971    .75822    .74700    .73606    .72538
77............................................................    .78004    .76897    .75815    .74758    .73726
78............................................................    .79010    .77944    .76902    .75883    .74886
79............................................................    .79993    .78968    .77965    .76984    .76023
80............................................................    .80955    .79971    .79008    .78064    .77140
81............................................................    .81891    .80948    .80024    .79118    .78230
82............................................................    .82796    .81894    .81009    .80140    .79288
83............................................................    .83672    .82810    .81962    .81131    .80314
84............................................................    .84525    .83700     82891    .82096    .81314
85............................................................    .85352    .84567    .83795    .83037    .82291
86............................................................    .86141    .85394    .84659    .83936    .83224
87............................................................    .86874    .86162    .85461    .84771    .84092
88............................................................    .87549    .86870    .86201    .85542    .84893
89............................................................    .88182    .87534    .86895    .86266    .85645
90............................................................    .88789    .88171    .87562     86961    .86369
91............................................................    .89367    .88779    .88198    .87625    .87059
92............................................................    .89900    .89338    .88784    .88237    .87697
93............................................................    .90379    .89842    .89312    .88788    .88271
94............................................................    .90803    .90288    .89780    .89277    .88781
95............................................................    .91171    .90675    .90185    .89701    .89223
96............................................................    .91481    .91001    .90527    .90058    .89594
97............................................................    .91757    .91291    .90831    .90376    .89926
98............................................................    .91999    .91546    .91098    .90655    .90217
99............................................................    .92227    .91786    .91349    .90917    .90490
100...........................................................    .92453    .92023    .91598    .91177    .90761
101...........................................................    .92656    .92236    .91821    .91410    .91003
102...........................................................    .92875    .92467    .92063    .91662    .91266
103...........................................................    .93152    .92758    .92367    .91980     91597
104...........................................................    .93423    .93042    .92665    .92291    .91920
105...........................................................    .93818    .93458    .93101    .92747    .92395
106...........................................................    .94430    .94104    .93779    .93457    .93127
107...........................................................     95256    .94975    .94696    .94418    .94143
108...........................................................    .96507     96298    .96090    .95883    .95676
109...........................................................    .98450    .98356    .98263    .98170    .98077
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  4.2%      4.4%      4.6%      4.8%      5.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .08811    .08132    .07534    .07006    .06539
1.............................................................    .07283    .06576    .05952    .05400    .04912
2.............................................................    .07471    .06746    .06106    .05539    .05037
3.............................................................    .07704    .06962    .06304    .05722    .05205
4.............................................................    .07962    .07202    .06528    .05930    .05398
5.............................................................    .08243    .07464    .06773    .06159    .05612
6.............................................................    .08542    .07745    .07037    .06406    .05844
7.............................................................    .08857    .08042    .07316    .06669    .06091
8.............................................................    .09189    .08355    .07612    .06948    .06354

[[Page 63]]

                                                                                                                
9.............................................................    .09540    .08687    .07926    .07245    .06635
10............................................................    .09908    .09037    .08258    .07560    .06934
11............................................................    .10296    .09406    .08609    .07894    .07251
12............................................................    .10701    .09793    .08977    .08245    .07586
13............................................................    .11119    .10191    .09358    .08608    .07932
14............................................................    .11544    .10597    .09745    .08978    .08285
15............................................................    .11972    .11007    .10136    .09350    .08640
16............................................................    .12402    .11416    .10527    .09723    .08995
17............................................................    .12832    .11827    .10919    .10096    .09351
18............................................................    .13268    .12243    .11315    .10474    .09711
19............................................................    .13712    .12667    .11720    .10860    .10078
20............................................................    .14170    .13105    .12138    .11259    .10459
21............................................................    .14642    .13557    .12570    .11671    .10853
22............................................................    .15129    .14024    .13017    .12099    .11261
23............................................................    .15634    .14508    .13481    .12544    .11687
24............................................................    .16159    .15013    .13967    .13009    .12133
25............................................................    .16709    .15543    .14477    .13500    .12604
26............................................................    .17286    .16101    .15014    .14018    .13103
27............................................................    .17891    .16686    .15580    .14564    .13630
28............................................................    .18525    .17301    .16175    .15140    .14187
29............................................................    .19183    .17940    .16796    .15742    .14770
30............................................................    .19867    .18606    .17443    .16370    .15380
31............................................................    .20574    .19295    .18114    .17023    .16013
32............................................................    .21307    .20010    .18811    .17702    .16674
33............................................................    .22064    .20751    .19535    .18407    .17362
34............................................................    .22846    .21516    .20283    .19138    .18075
35............................................................    .23653    .22307    .21058    .19896    .18816
36............................................................    .24484    .23124    .21859    .20681    .19584
37............................................................    .25340    .23966    .22685    .21492    .20379
38............................................................    .26219    .24831    .23536    .22328    .21199
39............................................................    .27120    .25720    .24411    .23188    .22044
40............................................................    .28045    .26633    .25311    .24075    .22916
41............................................................    .28992    .27569    .26236    .24986    .23814
42............................................................    .29965    .28532    .27188    .25926    .24741
43............................................................    .30960    .29518    .28163    .26890    .25693
44............................................................    .31977    .30527    .29164    .27880    .26671
45............................................................    .33013    .31557    .30185    .28892    .27673
46............................................................    .34071    .32609    .31230    .29929    .28700
47............................................................    .35148    .33681    .32296    .30988    .29750
48............................................................    .36246    .34777    .33387    .32072    .30826
49............................................................    .37364    .35893    .34499    .33179    .31927
50............................................................    .38503    .37030    .35634    .34310    .33053
51............................................................    .39659    .38187    .36790    .35462    .34201
52............................................................    .40832    .39362    .37965    .36636    .35371
53............................................................    .42021    .40554    .39158    .37829    .36562
54............................................................    .43222    .41760    .40367    .39039    .37771
55............................................................    .44436    .42980    .41591    .40264    .38997
56............................................................    .45660    .44212    .42828    .41504    .40239
57............................................................    .46897    .45456    .44079    .42760    .41498
58............................................................    .48142    .46712    .45342    .44030    .42771
59............................................................    .49399    .47980    .46620    .45314    .44062
60............................................................    .50666    .49260    .47910    .46613    .45367
61............................................................    .51944    .50552    .49214    .47927    .46690
62............................................................    .53232    .51856    .50531    .49256    .48028
63............................................................    .54529    .53169    .51860    .50598    .49381
64............................................................    .55832    .54491    .53198    .51950    .50746
65............................................................    .57140    .55819    .54544    .53312    .52121
66............................................................    .58451    .57152    .55895    .54681    .53506
67............................................................    .59763    .58486    .57251    .56054    .54896
68............................................................    .61076    .59823    .58609    .57432    .56292
69............................................................    .62390    .61162    .59971    .58816    .57695
70............................................................    .63705    .62503    .61337    .60204    .59104
71............................................................    .65023    .63849    .62709    .61600    .60522
72............................................................    .66344    .65199    .64086    .63003    .61949
73............................................................    .67661    .66547    .65463    .64407    .63378
74............................................................    .68964    .67882    .66827    .65798    .64796
75............................................................    .70243    .69193    .68168    .67168    .66192
76............................................................    .71495    .70477    .69482    .68511    .67563
77............................................................    .72717    .71731    .70768    .69826    .68905
78............................................................    .73912    .72959    .72026    .71114    .70221
79............................................................    .75083    .74163    .73262    .72379    .71515
80............................................................    .76235    .75348    .74479    .73627    .72792
81............................................................    .77360    .76506    .75669    .74848    .74043
82............................................................    .78452    .77632    .76827    .76036    .75260
83............................................................    .79513    .78725    .77952    .77192    .76446
84............................................................    .80547    .79792    .79051    .78322    .77606
85............................................................    .81557    .80836    .80126    .79429    .78742
86............................................................    .82524    .81835    .81157    .80489    .79832
87............................................................    .83423    .82764    .82115    .81477    .80847
88............................................................    .84253    .83623    .83002    .82390    .81787
89............................................................    .85033    .84430    .83836    .83250    .82672
90............................................................    .85784    .85208    .84639    .84079    .83525
91............................................................    .86502    .85951    .85408    .84871    .84342
92............................................................    .87164    .86638    .86118    .85605    .85098
93............................................................    .87761    .87257    .86759    .86267    .85781
94............................................................    .88290    .87806    .87327    .86854    .86386
95............................................................    .88750    .88282    .87820    .87364    .86913
96............................................................    .89136    .88683    .88236    .87793    .87355
97............................................................    .89481    .89041    .88606    .88176    .87750
98............................................................    .89783    .89354    .88930    .88511    .88096
99............................................................    .90067    .89649    .89235    .88826    .88420
100...........................................................    .90349    .89941    .89538    .89138    .88743
101...........................................................    .90600    .90202    .89807    .89416    .89029
102...........................................................    .90873    .90484    .90099    .89717    .89339
103...........................................................    .91217    .90841    .90468    .90099    .99733
104...........................................................    .91553    .91188    .90827    .90469    .90114
105...........................................................    .92047    .91701    .91358    .91018    .90680
106...........................................................    .92819    .92504    .92191    .91880    .91571
107...........................................................    .93868    .93596    .93325    .93056    .92788
108...........................................................    .95471    .95267    .95064    .94862    .94661
109...........................................................    .97985    .97893    .97801    .97710    .97619
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  5.2%      5.4%      5.6%      5.8%      6.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .06126    .05759    .05433    .05143    .04884
1.............................................................    .04480    .04096    .03754    .03450    .03179
2.............................................................    .04591    .04194    .03841    .03527    .03246
3.............................................................    .04745    .04336    .03972    .03646    .03355
4.............................................................    .04924    .04502    .04125    .03789    .03487
5.............................................................    .05124    .04689    .04300    .03952    .03639
6.............................................................    .05342    .04893    .04492    .04131    .03808
7.............................................................    .05574    .05112    .04697    .04324    .03990
8.............................................................    .05822    .05346    .04918    .04533    .04186
9.............................................................    .06089    .05598    .05156    .04759    .04400
10............................................................    .06372    .05866    .05411    .05000    .04630
11............................................................    .06673    .06153    .05684    .05260    .04877
12............................................................    .06992    .06457    .05973    .05536    .05141
13............................................................    .07322    .06772    .06274    .05824    .05415
14............................................................    .07659    .07093    .06581    .06117    .05695
15............................................................    .07998    .07417    .06890    .06411    .05976
16............................................................    .08337    .07739    .07197    .06704    .06255
17............................................................    .08675    .08062    .07504    .06996    .06533

[[Page 64]]

                                                                                                                
18............................................................    .09018    .08387    .07813    .07290    .06813
19............................................................    .09367    .08720    .08130    .07591    .07099
20............................................................    .09730    .09065    .08458    .07904    .07397
21............................................................    .10106    .09423    .08800    .08229    .07707
22............................................................    .10496    .09796    .09155    .08568    .08030
23............................................................    .10903    .10185    .09526    .08923    .08368
24............................................................    .11330    .10594    .09918    .09297    .08726
25............................................................    .11782    .11028    .10334    .09696    .09108
26............................................................    .12262    .11489    .10778    .10122    .09518
27............................................................    .12771    .11979    .11249    .10576    .09955
28............................................................    .13309    .12499    .11751    .11060    .10421
29............................................................    .13873    .13044    .12278    .11570    .10914
30............................................................    .14464    .13617    .12833    .12107    .11433
31............................................................    .15079    .14214    .13412    .12668    .11977
32............................................................    .15722    .14838    .14018    .13256    .12548
33............................................................    .16391    .15490    .14652    .13873    .13147
34............................................................    .17087    .16168    .15312    .14515    .13772
35............................................................    .17811    .16874    .16001    .15186    .14426
36............................................................    .18562    .17608    .16717    .15886    .15108
37............................................................    .19340    .18369    .17462    .16613    .15819
38............................................................    .20144    .19157    .18233    .17368    .16557
39............................................................    .20974    .19971    .19031    .18149    .17322
40............................................................    .21830    .20812    .19856    .18959    .18115
41............................................................    .22714    .21681    .20710    .19797    .18938
42............................................................    .23627    .22579    .21594    .20665    .19791
43............................................................    .24566    .23505    .22505    .21562    .20673
44............................................................    .25532    .24458    .23445    .22488    .21585
45............................................................    .26522    .25436    .24410    .23440    .22523
46............................................................    .27538    .26441    .25402    .24420    .23490
47............................................................    .28579    .27471    .26421    .25427    .24484
48............................................................    .29647    .28529    .27469    .26463    .25508
49............................................................    .30739    .29613    .28543    .27527    .26562
50............................................................    .31859    .30724    .29646    .28620    .27645
51............................................................    .33001    .31860    .30774    .29740    .28755
52............................................................    .34167    .33020    .31928    .30886    .29893
53............................................................    .35355    .34204    .33105    .32057    .31056
54............................................................    .36562    .35407    .34304    .33250    .32243
55............................................................    .37787    .36630    .35523    .34465    .33452
56............................................................    .39029    .37870    .36761    .35699    .34682
57............................................................    .40289    .39130    .38020    .36956    .35935
58............................................................    .41565    .40408    .39297    .38231    .37208
59............................................................    .42859    .41704    .40595    .39529    .38504
60............................................................    .44170    .43019    .41912    .40847    .39822
61............................................................    .45499    .44353    .43250    .42187    .41164
62............................................................    .46845    .45706    .44607    .43548    .42527
63............................................................    .48208    .47076    .45984    .44930    .43913
64............................................................    .49583    .48461    .47377    .46329    .45317
65............................................................    .50971    .49859    .48784    .47744    .46738
66............................................................    .52369    .51269    .50204    .49173    .48175
67............................................................    .53774    .52688    .51635    .50614    .49625
68............................................................    .55187    .54115    .53075    .52066    .51088
69............................................................    .56607    .55551    .54526    .53530    .52563
70............................................................    .58035    .56997    .55987    .55006    .54053
71............................................................    .59474    .58455    .57463    .56498    .55559
72............................................................    .60923    .59924    .58952    .58004    .57082
73............................................................    .62375    .61398    .60446    .59518    .58613
74............................................................    .63818    .62864    .61933    .61026    .60140
75............................................................    .65240    .64310    .63402    .62515    .61649
76............................................................    .66636    .65731    .64846    .63981    .63135
77............................................................    .68005    .67124    .66263    .65420    .64596
78............................................................    .69347    .68492    .67655    .66836    .66033
79............................................................    .70669    .69840    .69028    .68232    .67452
80............................................................    .71973    .71171    .70384    .69613    .68856
81............................................................    .73252    .72477    .71717    .70970    .70237
82............................................................    .74499    .73751    .73016    .72295    .71587
83............................................................    .75713    .74992    .74284    .73589    .72905
84............................................................    .76901    .76208    .75527    .74857    .74198
85............................................................    .78067    .77402    .76748    .76104    .75471
86............................................................    .79185    .78548    .77921    .77304    .76695
87............................................................    .80228    .79617    .79015    .78423    .77838
88............................................................    .81193    .80607    .80029    .79460    .78899
89............................................................    .82102    .81540    .80985    .80438    .79899
90............................................................    .82979    .82441    .81909    .81384    .80867
91............................................................    .83820    .83304    .82795    .82292    .81796
92............................................................    .84598    .84104    .83616    .83134    .82657
93............................................................    .85300    .84826    .84357    .83894    .83437
94............................................................    .85924    .85468    .85017    .84570    .84130
95............................................................    .86466    .86025    .85589    .85158    .84732
96............................................................    .86922    .86494    .86071    .85652    .85238
97............................................................    .87329    .86913    .86501    .86093    .85690
98............................................................    .87685    .87279    .86877    .86479    .86085
99............................................................    .88019    .87622    .87230    .86841    .86456
100...........................................................    .88351    .87964    .87580    .87200    .86824
101...........................................................    .88646    .88267    .87891    .87519    .87150
102...........................................................    .88965    .88594    .88227    .87863    .87503
103...........................................................    .89370    .89011    .88654    .88301    .87952
104...........................................................    .89763    .89414    .89068    .88725    .88385
105...........................................................    .90345    .90013    .89683    .89356    .89032
106...........................................................    .91265    .90961    .90658    .90358    .90060
107...........................................................    .92522    .92258    .91995    .91734    .91474
108...........................................................    .94461    .94262    .94063    .93866    .93670
109...........................................................    .97529    .97438    .97348    .97259    .97170
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  6.2%      6.4%      6.6%      6.8%      7.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .04653    .04447    .04262    .04095    .03946
1.............................................................    .02937    .02720    .02525    .02351    .02194
2.............................................................    .02994    .02769    .02567    .02385    .02221
3.............................................................    .03094    .02860    .02650    .02460    .02290
4.............................................................    .03216    .02973    .02755    .02558    .92380
5.............................................................    .03359    .03106    .02879    .02674    .02488
6.............................................................    .03517    .03255    .03019    .02805    .02612
7.............................................................    .03688    .03416    .03171    .02949    .02747
8.............................................................    .03874    .03592    .03337    .03106    .02896
9.............................................................    .04077    .03784    .03519    .03279    .03061
10............................................................    .04295    .03992    .03717    .03467    .03240
11............................................................    .04531    .04217    .03931    .03672    .03436
12............................................................    .04782    .04457    .04161    .03892    .02647
13............................................................    .05045    .04708    .04402    .04122    .03868
14............................................................    .05312    .04964    .04646    .04357    .04093
15............................................................    .05581    .05220    .04891    .04591    .04317
16............................................................    .05847    .05474    .05134    .04822    .04538
17............................................................    .06111    .05726    .05374    .05051    .04756
18............................................................    .06378    .05979    .05615    .05280    .04974
19............................................................    .06650    .06238    .05861    .05514    .05196
20............................................................    .06933    .06507    .06117    .05758    .05429
21............................................................    .07228    .06788    .06384    .06013    .05671
22............................................................    .07535    .07081    .06664    .06279    .05925
23............................................................    .07858    .07389    .06958    .06559    .06192
24............................................................    .08201    .07717    .07270    .06858    .06477
25............................................................    .08567    .08067    .07606    .07179    .06785
26............................................................    .08960    .08444    .07968    .07527    .07118

[[Page 65]]

                                                                                                                
27............................................................    .09380    .08849    .08357    .07901    .07478
28............................................................    .09830    .09283    .08775    .08304    .07867
29............................................................    .10306    .09742    .09218    .08732    .08280
30............................................................    .10808    .10228    .09688    .09187    .08720
31............................................................    .11335    .10738    .10182    .09665    .09182
32............................................................    .11889    .11275    .10704    .10170    .09672
33............................................................    .12471    .11840    .11252    .10703    .10189
34............................................................    .13079    .12432    .11827    .11261    .10732
35............................................................    .13716    .13052    .12431    .11849    .11305
36............................................................    .14381    .13701    .13063    .12465    .11905
37............................................................    .15075    .14378    .13724    .13110    .12534
38............................................................    .15796    .15083    .14412    .13782    .13190
39............................................................    .16545    .15815    .15129    .14483    .13875
40............................................................    .17322    .16576    .15874    .15212    .14589
41............................................................    .18129    .17367    .16649    .15971    .15332
42............................................................    .18967    .18190    .17456    .16763    .16108
43............................................................    .19834    .19041    .18293    .17585    .16915
44............................................................    .20731    .19924    .19160    .18437    .17753
45............................................................    .21655    .20834    .20055    .19318    .18619
46............................................................    .22608    .21773    .20981    .20229    .19516
47............................................................    .23590    .22741    .21935    .21170    .20443
48............................................................    .24602    .23741    .22922    .22144    .21403
49............................................................    .25644    .24770    .23939    .23148    .22394
50............................................................    .26716    .25831    .24989    .24185    .23419
51............................................................    .27816    .26921    .26068    .25253    .24475
52............................................................    .28945    .28040    .27176    .26351    .25562
53............................................................    .30100    .29187    .28313    .27478    .26679
54............................................................    .31279    .30357    .29475    .28631    .27822
55............................................................    .32482    .31553    .30663    .29810    .28992
56............................................................    .33707    .32771    .31875    .31014    .30188
57............................................................    .34955    .34015    .33112    .32244    .31411
58............................................................    .36225    .35280    .34372    .33499    .32659
59............................................................    .37519    .36571    .35659    .34781    .33936
60............................................................    .38836    .37886    .36971    .36089    .35239
61............................................................    .40177    .39226    .38309    .37425    .36572
62............................................................    .41542    .40591    .39674    .38788    .37932
63............................................................    .42930    .41981    .41064    .40178    .39321
64............................................................    .44338    .43392    .42477    .41591    .40734
65............................................................    .45765    .44823    .43910    .43027    .42171
66............................................................    .47208    .46271    .45364    .44483    .43630
67............................................................    .48666    .47736    .46834    .45958    .45108
68............................................................    .50138    .49215    .48320    .47450    .46605
69............................................................    .51624    .50711    .49824    .48961    .48122
70............................................................    .53125    .52223    .51345    .50491    .49660
71............................................................    .54645    .53755    .52889    .52045    .51223
72............................................................    .56183    .55307    .54453    .53621    .52809
73............................................................    .57731    .56870    .56030    .55211    .54412
74............................................................    .59275    .58431    .57606    .56801    .56015
75............................................................    .60803    .59976    .59168    .58379    .57607
76............................................................    .62308    .61500    .60709    .59936    .59179
77............................................................    .63789    .63000    .62227    .61470    .60730
78............................................................    .65247    .64477    .63723    .62984    .62261
79............................................................    .66687    .65938    .65203    .64483    .63777
80............................................................    .68114    .67386    .66672    .65971    .65284
81............................................................    .69518    .68812    .68119    .67438    .66770
82............................................................    .70891    .70207    .69535    .68875    .68227
83............................................................    .72232    .71572    .70922    .70283    .69655
84............................................................    .73550    .72913    .72285    .71668    .71061
85............................................................    .74847    .74234    .73630    .73035    .72449
86............................................................    .76096    .75506    .74925    .74353    .73789
87............................................................    .77263    .76696    .76137    .75585    .75042
88............................................................    .78345    .77799    .77261    .76730    .76207
89............................................................    .79367    .78842    .78323    .77812    .77308
90............................................................    .80356    .79851    .79353    .78862    .78376
91............................................................    .81306    .80821    .80344    .79871    .79405
92............................................................    .82187    .81722    .81263    .80810    .80361
93............................................................    .82984    .82538    .82096    .81659    .81228
94............................................................    .83694    .83263    .82837    .82416    .81999
95............................................................    .84310    .83893    .83481    .83073    .82670
96............................................................    .84829    .84424    .84023    .83626    .83234
97............................................................    .85291    .84897    .84506    .84120    .83738
98............................................................    .85696    .85310    .84929    .84551    .84177
99............................................................    .86075    .85698    .85325    .84956    .84590
100...........................................................    .86452    .86084    .85719    .85357    .85000
101...........................................................    .86785    .86424    .86066    .85711    .85360
102...........................................................    .87146    .86792    .86442    .86094    .85750
103...........................................................    .87605    .87261    .86921    .86583    .86248
104...........................................................    .88047    .87713    .87382    .87053    .86727
105...........................................................    .88710    .88390    .88073    .87758    .87446
106...........................................................    .89764    .89471    .89179    .88889    .88601
107...........................................................    .91216    .90960    .90705    .90451    .90199
108...........................................................    .93474    .93280    .93086    .92894    .92702
109...........................................................    .97081    .96992    .96904    .96816    .96729
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  7.2%      7.4%      7.6%      7.8%      8.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03811    .03689    .03579    .03479    .03388
1.............................................................    .02052    .01924    .01809    .01704    .01609
2.............................................................    .02074    .01940    .01819    .01710    .01611
3.............................................................    .02136    .01996    .01870    .01756    .01652
4.............................................................    .02219    .02074    .01942    .01822    .01713
5.............................................................    .02321    .02169    .02031    .01905    .01791
6.............................................................    .02437    .02278    .02134    .02003    .01883
7.............................................................    .02565    .02399    .02248    .02111    .01986
8.............................................................    .02706    .02533    .02376    .02232    .02101
9.............................................................    .02863    .02682    .02518    .02367    .02230
10............................................................    .03034    .02846    .02674    .02517    .02373
11............................................................    .03221    .03025    .02846    .02682    .02532
12............................................................    .03424    .03219    .03032    .02861    .02704
13............................................................    .03635    .03422    .03228    .03049    .02885
14............................................................    .03851    .03630    .03427    .03240    .03069
15............................................................    .04066    .03836    .03624    .03430    .03252
16............................................................    .04277    .04037    .03817    .03615    .03429
17............................................................    .04485    .04236    .04007    .03796    .03602
18............................................................    .04693    .04434    .04196    .03976    .03773
19............................................................    .04904    .04635    .04387    .04159    .03947
20............................................................    .05125    .04845    .04588    .04349    .04129
21............................................................    .05356    .05065    .04797    .04549    .04319
22............................................................    .05597    .05295    .05016    .04758    .04519
23............................................................    .05853    .05539    .05248    .04979    .04730
24............................................................    .06124    .05799    .05497    .05217    .04957
25............................................................    .06420    .06081    .05767    .05475    .05205
26............................................................    .06739    .06388    .06062    .05758    .05476
27............................................................    .07086    .06721    .06382    .06067    .05773
28............................................................    .07460    .07082    .06730    .06402    .06097
29............................................................    .07859    .07467    .07102    .06762    .06444
30............................................................    .08284    .07879    .07500    .07146    .06815
31............................................................    .08733    .08312    .07920    .07553    .07209
32............................................................    .09207    .08773    .08366    .07986    .07629
33............................................................    .09709    .09260    .08839    .08445    .08075
34............................................................    .10237    .09773    .09338    .08929    .08546
35............................................................    .10794    .10315    .09865    .09442    .09045

[[Page 66]]

                                                                                                                
36............................................................    .11379    .10884    .10420    .09983    .09572
37............................................................    .11992    .11483    .11003    .10552    .10126
38............................................................    .12633    .12108    .11614    .11148    .10708
39............................................................    .13302    .12762    .12253    .11772    .11318
40............................................................    .14000    .13445    .12921    .12425    .11957
41............................................................    .14728    .14158    .13619    .13109    .12626
42............................................................    .15490    .14904    .14350    .13825    .13328
43............................................................    .16260    .15680    .15111   .145072    .14060
44............................................................     17104    .16488    .15905    .15351    .14825
45............................................................    .17955    .17326    .16727    .16159    .15619
46............................................................    .18838    .18194    .17582    .16999    .16445
47............................................................    .19751    .19093    .18467    .17870    .17302
48............................................................    .20698    .20026    .19386    .18776    .18194
49............................................................    .21676    .20991    .20338    .19715    .19119
50............................................................    .22689    .21991    .21325    .20689    .20080
51............................................................    .23732    .23023    .22344    .21695    .21074
52............................................................    .24808    .24086    .23396    .22735    .22102
53............................................................    .25914    .25181    .24479    .23807    .24252
54............................................................    .27047    .26304    .25591    .24908    .25372
55............................................................    .28208    .27455    .26733    .26039    .25372
56............................................................    .29395    .28633    .37901    .27197    .26521
57............................................................    .30610    .29840    .29099    .28386    .27700
58............................................................    .31851    .31074    .30325    .29604    .28909
59............................................................    .33122    .32337    .31581    .30853    .30150
60............................................................    .34420    .33630    .32867    .32132    .31422
61............................................................    .35748    .34953    .34185    .33444    .32727
62............................................................    .37106    .36307    .35535    .34788    .34066
63............................................................    .38492    .37691    .36915    .36165    .35438
64............................................................    .39905    .39102    .38324    .37571    .36841
65............................................................    .41342    .40539    .39760    .39005    .38272
66............................................................    .42803    .42000    .41221    .40465    .39731
67............................................................    .44283    .43483    .42705    .41949    .41215
68............................................................    .45784    .44987    .44211    .43457    .42724
69............................................................    .47307    .46513    .45741    .44990    .44254
70............................................................    .48851    .48063    .47296    .46549    .45821
71............................................................    .50422    .49641    .48880    .48139    .47416
72............................................................    .52018    .51246    .50493    .49758    .49042
73............................................................    .53631    .52870    .52126    .51400    .50691
74............................................................    .55247    .54497    .53764    .53048    .52347
75............................................................    .56852    .56115    .55393    .54687    .53997
76............................................................    .58439    .57714    .57005    .56311    .55632
77............................................................    .60005    .59294    .58599    .57917    .57249
78............................................................    .61551    .60856    .60174    .59506    .58851
79............................................................    .63084    .62405    .61739    .61085    .60443
80............................................................    .64609    .63946    .63296    .62657    .62030
81............................................................    .66114    .65469    .64835    .64213    .63602
82............................................................    .67589    .66963    .66347    .65742    .65146
83............................................................    .60937    .68429    .67831    .67243    .66664
84............................................................    .70463    .69875    .69296    .68726    .68165
85............................................................    .71872    .71304    .70745    .70194    .69651
86............................................................    .73233    .72685    .72146    .71614    .71089
87............................................................    .74507    .73978    .73458    .72944    .72438
88............................................................    .75691    .75181    .74679    .74183    .73694
89............................................................    .76810    .76319    .75834    .75355    .74883
90............................................................    .77897    .77424    .76957    .76496    .76040
91............................................................    .78945    .78490    .78040    .77596    .77158
92............................................................    .79919    .79481    .79048    .78621    .78198
93............................................................    .80801    .80380    .79963    .79550    .79143
94............................................................    .81587    .81180    .80777    .80379    .79985
95............................................................    .82271    .81877    .81487    .81100    .80719
96............................................................    .82846    .82462    .82083    .81707    .81335
97............................................................    .83360    .82985    .82615    .82248    .81885
98............................................................    .33808    .83441    .83079    .82720    .82365
99............................................................    .84228    .83869    .83514    .83163    .82815
100...........................................................    .84645    .84294    .83947    .83603    .83262
101...........................................................    .85012    .84668    .84327    .83988    .83653
102...........................................................    .85409    .85072    .84737    .84405    .84077
103...........................................................    .85917    .85588    .85262    .84939    .84619
104...........................................................    .86403    .86083    .85765    .85449    .85136
105...........................................................    .87136    .86829    .86524    .86221    .85921
106...........................................................    .88315    .88032    .87750    .87470    .87192
107...........................................................    .89949    .89700    .89452    .89206    .88961
108...........................................................    .92511    .92321    .92132    .91944    .91757
109...........................................................    .96642    .96555    .96468    .96382    .96296
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  8.2%      8.4%      8.6%      8.8%      9.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03305    .03230    .03161    .03098    .03040
1.............................................................    .01523    .01444    .01372    .01307    .01247
2.............................................................    .01520    .01438    .01362    .01294    .01230
3.............................................................    .01557    .01470    .01391    .01319    .01253
4.............................................................    .01613    .01522    .01439    .01363    .01294
5.............................................................    .01687    .01591    .01504    .01424    .01351
6.............................................................    .01774    .01674    .01582    .01498    .01421
7.............................................................    .01871    .01766    .01670    .01581    .01500
8.............................................................    .01980    .01870    .01769    .01676    .01591
9.............................................................    .02104    .01989    .01883    .01785    .01695
10............................................................    .02241    .02120    .02009    .01906    .01812
11............................................................    .02394    .02267    .02150    .02042    .01943
12............................................................    .02560    .02427    .02305    .02192    .02088
13............................................................    .02734    .02595    .02467    .02349    .02240
14............................................................    .02912    .02766    .02632    .02509    .02394
15............................................................    .03087    .02935    .02795    .02666    .02546
16............................................................    .03257    .03099    .02952    .02817    .02691
17............................................................    .03423    .03257    .03104    .02962    .02831
18............................................................    .03586    .03414    .03253    .03105    .02967
19............................................................    .03752    .03572    .03404    .03249    .03105
20............................................................    .03925    .03737    .03562    .03399    .03248
21............................................................    .04107    .03910    .03727    .03557    .03398
22............................................................    .04297    .04091    .03899    .03722    .03556
23............................................................    .04498    .04283    .04083    .03897    .03723
24............................................................    .04715    .04491    .04282    .04087    .03905
25............................................................    .04953    .04718    .04499    .04295    .04105
26............................................................    .05213    .04968    .04740    .04527    .04327
27............................................................    .05499    .05243    .05005    .04782    .04573
28............................................................    .05811    .05545    .05295    .05062    .04844
29............................................................    .06146    .05868    .05608    .05365    .05136
30............................................................    .06506    .06217    .05945    .05691    .05452
31............................................................    .06888    .06586    .06303    .06038    .05789
32............................................................    .07295    .06981    .06687    .06410    .06149
33............................................................    .07728    .07401    .07095    .06806    .06535
34............................................................    .08185    .07846    .07527    .07227    .06944
35............................................................    .08671    .08319    .07988    .07675    .07380
36............................................................    .09184    .08819    .08475    .08150    .07843
37............................................................    .09725    .09347    .08989    .08652    .08332
38............................................................    .10293    .09901    .09531    .09180    .08848
39............................................................    .10889    .10483    .10099    .09736    .09391
40............................................................    .11514    .11094    .10697    .10320    .09963
41............................................................    .12168    .11735    .11324    .10934    .10564
42............................................................    .12856    .12409    .11984    .11581    .11197
43............................................................    .13574    .13113    .12675    .12258    .11862
44............................................................    .14325    .13850    .13398    .12967    .12558

[[Page 67]]

                                                                                                                
45............................................................    .15105    .14616    .14150    .13706    .13283
46............................................................    .15917    .15414    .14935    .14478    .14041
47............................................................    .16760    .16244    .15751    .15280    .14831
48............................................................    .17639    .17109    .16602    .16119    .15656
49............................................................    .18551    .18007    .17488    .16991    .16516
50............................................................    .19499    .18942    .18410    .17900    .17412
51............................................................    .20480    .19911    .19366    .18844    .18343
52............................................................    .21495    .20914    .20357    .19822    .19309
53............................................................    .22544    .21951    .21381    .20835    .20309
54............................................................    .23622    .23018    .22437    .21878    .21341
55............................................................    .24732    .24116    .23524    .22954    .22406
56............................................................    .25870    .25244    .24641    .24060    .23501
57............................................................    .27040    .26404    .25791    .25200    .24630
58............................................................    .28239    .27594    .26971    .26370    .25791
59............................................................    .29472    .28817    .28186    .27576    .26987
60............................................................    .30736    .30074    .29434    .28816    .28218
61............................................................    .32035    .31365    .30718    .30092    .29486
62............................................................    .33368    .32692    .32038    .31405    .30791
63............................................................    .34735    .34054    .33394    .32754    .32134
64............................................................    .36133    .35448    .34783    .34138    .33512
65............................................................    .37562    .36873    .36204    .35554    .34924
66............................................................    .39019    .38327    .37655    .37002    .36367
67............................................................    .40502    .39809    .39134    .38479    .37841
68............................................................    .42011    .41317    .40642    .39985    .39345
69............................................................    .43547    .42854    .42179    .41522    .40882
70............................................................    .45112    .44421    .43748    .43091    .42451
71............................................................    .46711    .46023    .45352    .44698    .44059
72............................................................    .48342    .47659    .46992    .46341    .45705
73............................................................    .49998    .49321    .48660    .48014    .47382
74............................................................    .51663    .50994    .50339    .49699    .49073
75............................................................    .53322    .52661    .52014    .51381    .50762
76............................................................    .54967    .54315    .53678    .53053    .52440
77............................................................    .56595    .55954    .55326    .54710    .54106
78............................................................    .58209    .57579    .56961    .56355    .55761
79............................................................    .59814    .59196    .58590    .57995    .57410
80............................................................    .61415    .60810    .60217    .59633    .59060
81............................................................    .63001    .62410    .61830    .61260    .60699
82............................................................    .64561    .63985    .63419    .62862    .62314
83............................................................    .66095    .65535    .64983    .64441    .63907
84............................................................    .67612    .67068    .66533    .66005    .65486
85............................................................    .69116    .68589    .68070    .67559    .67055
86............................................................    .70573    .70063    .69561    .69066    .68578
87............................................................    .71939    .71446    .70961    .70481    .70009
88............................................................    .73211    .72735    .72265    .71801    .71343
89............................................................    .74417    .73956    .73501    .73053    .72609
90............................................................    .75590    .75146    .74707    .74273    .73845
91............................................................    .76724    .76296    .75873    .75454    .75041
92............................................................    .77781    .77368    .76960    .76556    .76158
93............................................................    .78740    .78342    .77948    .77558    .77173
94............................................................    .79596    .79210    .78829    .78452    .78079
95............................................................    .80341    .79967    .79597    .79231    .78869
96............................................................    .80967    .80603    .80242    .79885    .79532
97............................................................    .81526    .81170    .80818    .80470    .80125
98............................................................    .82013    .81665    .81320    .80979    .80641
99............................................................    .82470    .82129    .81791    .81456    .81125
100...........................................................    .82924    .82590    .82258    .81930    .81605
101...........................................................    .83322    .82993    .82667    .82344    .82024
102...........................................................    .83751    .83428    .83108    .82791    .82477
103...........................................................    .84301    .83986    .83674    .83365    .83058
104...........................................................    .84826    .84518    .84213    .83910    .83610
105...........................................................    .85623    .85327    .85033    .84741    .84452
106...........................................................    .86915    .86641    .86369    .86098    .85829
107...........................................................    .88718    .88476    .88236    .87997    .87759
108...........................................................    .91571    .91385    .91201    .91017    .90834
109...........................................................    .96211    .96125    .96041    .95956    .95872
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  9.2%      9.4%      9.6%      9.8%      10.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02987    .02938    .02893    .02851    .02812
1.............................................................    .01192    .01141    .01094    .01051    .01012
2.............................................................    .01173    .01119    .01070    .01025    .00983
3.............................................................    .01192    .01136    .01084    .01036    .00992
4.............................................................    .01229    .01170    .01116    .01066    .01019
5.............................................................    .01283    .01221    .01164    .01111    .01062
6.............................................................    .01350    .01284    .01224    .01168    .01116
7.............................................................    .01425    .01356    .01292    .01233    .01178
8.............................................................    .01512    .01439    .01372    .01309    .01252
9.............................................................    .01612    .01535    .01464    .01398    .01337
10............................................................    .01724    .01644    .01569    .01499    .01435
11............................................................    .01851    .01766    .01688    .01615    .01547
12............................................................    .01991    .01902    .01819    .01742    .01671
13............................................................    .02139    .02045    .01958    .01877    .01802
14............................................................    .02288    .02190    .02098    .02013    .01934
15............................................................    .02435    .02331    .02235    .02146    .02063
16............................................................    .02575    .02466    .02366    .02272    .02185
17............................................................    .02709    .02595    .02490    .02391    .02300
18............................................................    .02839    .02721    .02610    .02507    .02410
19............................................................    .02971    .02846    .02730    .02621    .02520
20............................................................    .03108    .02977    .02855    .02741    .02635
21............................................................    .03251    .03114    .02986    .02866    .02755
22............................................................    .03402    .03258    .03123    .02998    .02880
23............................................................    .03562    .03410    .03269    .03137    .03014
24............................................................    .03735    .03577    .03428    .03290    .03159
25............................................................    .03927    .03761    .03605    .03459    .03322
26............................................................    .04141    .03966    .03803    .03649    .03505
27............................................................    .04377    .04194    .04023    .03861    .03710
28............................................................    .04639    .04447    .04267    .04098    .03938
29............................................................    .04922    .04721    .04532    .04354    .04187
30............................................................    .05228    .05017    .04819    .04633    .04457
31............................................................    .05554    .05334    .05126    .04930    .04746
32............................................................    .05904    .05674    .05456    .05251    .05058
33............................................................    .06279    .06038    .05810    .05595    .05392
34............................................................    .06677    .06435    .06187    .05962    .05750
35............................................................    .07102    .06839    .06590    .06355    .06132
36............................................................    .07553    .07278    .07019    .06773    .06540
37............................................................    .08030    .07745    .07474    .07217    .06974
38............................................................    .08534    .08237    .07955    .07687    .07433
39............................................................    .09065    .08755    .08462    .08182    .07917
40............................................................    .09624    .09302    .08996    .08706    .08429
41............................................................    .10212    .09878    .09560    .09258    .08970
42............................................................    .10833    .10486    .10156    .09842    .09543
43............................................................    .11484    .11125    .10783    .10456    .10145
44............................................................    .12167    .11795    .11441    .11102    .10779
45............................................................    .12880    .12495    .12128    .11777    .11442
46............................................................    .13625    .13227    .12847    .12484    .12137
47............................................................    .14402    .13991    .13599    .13223    .12863
48............................................................    .15214    .14791    .14385    .13997    .13626
49............................................................    .16060    .15625    .15207    .14806    .14422
50............................................................    .16944    .16496    .16065    .15653    .15257
51............................................................    .17862    .17401    .16959    .16534    .16126
52............................................................    .18816    .18343    .17888    .17451    .17031
53............................................................    .19805    .19320    .18853    .18404    .17972
54............................................................    .20825    .20328    .19850    .19390    .18946
55............................................................    .21878    .21370    .20881    .20409    .19954
56............................................................    .22963    .22443    .21943    .21460    .20994
57............................................................    .24081    .23551    .23040    .22546    .22069
58............................................................    .25231    .24691    .24170    .23665    .23178
59............................................................    .26418    .25868    .25336    .24822    .24325
60............................................................    .27640    .27081    .26540    .26016    .25509
61............................................................    .28899    .28332    .27782    .27249    .26733
62............................................................    .30197    .29622    .29064    .28523    .27998
63............................................................    .31533    .30950    .30385    .29836    .29304
64............................................................    .32905    .32316    .31743    .31188    .30648
65............................................................    .34311    .33716    .33138    .32576    .32030

[[Page 68]]

                                                                                                                
66............................................................    .35751    .35151    .34568    .34001    .33449
67............................................................    .37221    .36618    .36030    .35459    .34902
68............................................................    .38723    .38116    .37526    .36950    .36390
69............................................................    .40257    .39649    .39056    .38478    .37914
70............................................................    .41826    .41217    .40623    .40043    .39478
71............................................................    .43435    .42827    .42233    .41652    .41086
72............................................................    .45084    .44478    .43885    .43305    .42739
73............................................................    .46765    .46161    .45571    .44994    .44429
74............................................................    .48460    .47861    .47274    .46700    .46138
75............................................................    .50155    .49561    .48979    .48409    .47851
76............................................................    .51841    .51253    .50677    .50112    .49559
77............................................................    .53514    .52934    .52364    .51806    .51258
78............................................................    .55177    .54605    .54043    .53492    .52951
79............................................................    .56837    .56273    .55720    .55177    .54643
80............................................................    .58497    .57944    .57401    .56866    .56341
81............................................................    .60148    .59606    .59073    .58548    .58033
82............................................................    .61775    .61245    .60723    .60210    .59705
83............................................................    .63381    .62863    .62354    .61852    .61358
84............................................................    .64974    .64470    .63973    .63484    .63002
85............................................................    .66558    .66068    .65586    .65110    .64641
86............................................................    .68096    .67622    .67154    .66692    .66236
87............................................................    .69542    .69082    .68628    .68180    .67738
88............................................................    .70891    .70445    .70005    .69570    .69141
89............................................................    .72172    .71739    .71312    .70891    .70474
90............................................................    .73422    .73004    .72591    .72182    .71779
91............................................................    .74632    .74229    .73829    .73435    .73045
92............................................................    .75763    .75373    .74988    .74606    .74229
93............................................................    .76791    .76414    .76042    .75673    .75308
94............................................................    .77710    .77345    .76983    .76626    .76272
95............................................................    .78510    .78155    .77804    .77457    .77113
96............................................................    .79183    .78837    .78494    .78155    .77819
97............................................................    .79783    .79445    .79110    .78779    .78450
98............................................................    .80306    .79975    .79647    .79322    .79000
99............................................................    .80797    .80471    .80149    .79830    .79514
100...........................................................    .81283    .80964    .80648    .80335    .80025
101...........................................................    .81708    .81394    .81082    .80774    .80468
102...........................................................    .82165    .81856    .81550    .81247    .80946
103...........................................................    .82754    .82452    .82153    .81857    .81563
104...........................................................    .83312    .83017    .82723    .82433    .82144
105...........................................................    .84165    .83880    .83597    .83316    .83038
106...........................................................    .85562    .85297    .85034    .84772    .84512
107...........................................................    .87523    .87288    .87054    .86822    .86591
108...........................................................    .90652    .90471    .90291    .90111    .89932
109...........................................................    .95788    .95704    .95620    .95537    .95455
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  10.2%     10.4%     10.6%     10.8%     11.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02776    .02743    .02712    .02682    .02655
1.............................................................    .00975    .00941    .00909    .00880    .00852
2.............................................................    .00945    .00909    .00875    .00844    .00816
3.............................................................    .00952    .00914    .00879    .00846    .00815
4.............................................................    .00976    .00936    .00899    .00865    .00832
5.............................................................    .01016    .00974    .00935    .00898    .00864
6.............................................................    .01068    .01023    .00981    .00943    .00907
7.............................................................    .01128    .01080    .01036    .00995    .00957
8.............................................................    .01198    .01148    .01101    .01058    .01017
9.............................................................    .01281    .01228    .01179    .01133    .01090
10............................................................    .01375    .01319    .01267    .01219    .01173
11............................................................    .01483    .01425    .01370    .01318    .01270
12............................................................    .01604    .01542    .01484    .01430    .01379
13............................................................    .01732    .01666    .01605    .01548    .01494
14............................................................    .01860    .01792    .01727    .01667    .01610
15............................................................    .01986    .01913    .01845    .01782    .01723
16............................................................    .02103    .02027    .01956    .01889    .01827
17............................................................    .02214    .02134    .02059    .01989    .01923
18............................................................    .02320    .02236    .02157    .02084    .02014
19............................................................    .02426    .02337    .02254    .02177    .02104
20............................................................    .02536    .02442    .02355    .02273    .02197
21............................................................    .02650    .02552    .02460    .02374    .02293
22............................................................    .02770    .02667    .02570    .02479    .02394
23............................................................    .02898    .02789    .02687    .02591    .02501
24............................................................    .03037    .02923    .02815    .02714    .02619
25............................................................    .03194    .03073    .02960    .02853    .02752
26............................................................    .03370    .03243    .03123    .03010    .02904
27............................................................    .03568    .03434    .03307    .03188    .03076
28............................................................    .03789    .03647    .03514    .03389    .03271
29............................................................    .04029    .03880    .03740    .03608    .03483
30............................................................    .04291    .04135    .03987    .03848    .03716
31............................................................    .04572    .04407    .04252    .04105    .03966
32............................................................    .04875    .04702    .04538    .04384    .04237
33............................................................    .05200    .05019    .04847    .04684    .04530
34............................................................    .05548    .05358    .05177    .05006    .04843
35............................................................    .05921    .05722    .05532    .05352    .05181
36............................................................    .06319    .06110    .05911    .05722    .05543
37............................................................    .06743    .06524    .06315    .06117    .05929
38............................................................    .07191    .06962    .06744    .06536    .06338
39............................................................    .07665   .074425    .07197    .06980    .06773
40............................................................    .08166    .07916    .07677    .07450    .07233
41............................................................    .08696    .08434    .08185    .07947    .07721
42............................................................    .09257    .08985    .08725    .08477    .08239
43............................................................    .09848    .09564    .09293    .09034    .08787
44............................................................    .10470    .10175    .09893    .09623    .09365
45............................................................    .11121    .10815    .10522    .10241    .09972
46............................................................    .11805    .11486    .11182    .10890    .10610
47............................................................    .12519    .12189    .11873    .11569    .11279
48............................................................    .13269    .12927    .12600    .12285    .11983
49............................................................    .14054    .13600    .13361    .13035    .12721
50............................................................    .14876    .14511    .14160    .13822    .13497
51............................................................    .15734    .15356    .14994    .14645    .14309
52............................................................    .16627    .16238    .15864    .15504    .15156
53............................................................    .17557    .17156    .16770    .16399    .16040
54............................................................    .18519    .18107    .17710    .17327    .16957
55............................................................    .19515    .19092    .18684    .18290    .17909
56............................................................    .20544    .20110    .19691    .19286    .18894
57............................................................    .21609    .21164    .20734    .20318    .19916
58............................................................    .22707    .22252    .21811    .21385    .20972
59............................................................    .23844    .23378    .22928    .22491    .22068
60............................................................    .25018    .24543    .24082    .23636    .23203
61............................................................    .26233    .25749    .25279    .24823    .24381
62............................................................    .27490    .26996    .26517    .26052    .25601
63............................................................    .28787    .28286    .27798    .27325    .26865
64............................................................    .30124    .29615    .29120    .28639    .28171
65............................................................    .31500    .30983    .30481    .29993    .29517
66............................................................    .32912    .32390    .31881    .31386    .30904
67............................................................    .34360    .33832    .33318    .32817    .32328
68............................................................    .35843    .35311    .34791    .34285    .33791
69............................................................    .37365    .36828    .36305    .35794    .35296
70............................................................    .38925    .38386    .37860    .37346    .36844
71............................................................    .40532    .39991    .39463    .38946    .38442
72............................................................    .42185    .41644    .41115    .40597    .40091
73............................................................    .43876    .43336    .42807    .42289    .41782
74............................................................    .45588    .45050    .44522    .44005    .43499

[[Page 69]]

                                                                                                                
75............................................................    .47304    .46769    .46244    .45729    .45225
76............................................................    .49016    .48485    .47963    .47451    .46949
77............................................................    .50721    .50193    .49676    .49168    .48670
78............................................................    .52419    .51898    .51385    .50882    .50388
79............................................................    .54119    .53604    .53097    .52600    .52111
80............................................................    .55825    .55318    .54819    .54328    .53846
81............................................................    .57526    .57027    .56536    .56053    .55578
82............................................................    .59208    .58718    .58236    .57762    .57295
83............................................................    .60871    .60392    .59920    .59455    .58997
84............................................................    .62527    .62059    .61597    .61143    .60695
85............................................................    .64179    .63723    .63273    .62830    .62393
86............................................................    .65787    .65344    .64907    .64475    .64050
87............................................................    .67302    .66871    .66446    .66026    .65612
88............................................................    .68717    .68298    .67885    .67477    .67074
89............................................................    .70063    .69656    .69255    .68858    .68466
90............................................................    .71380    .70986    .70597    .70212    .69831
91............................................................    .72659    .72278    .71901    .71528    .71160
92............................................................    .73856    .73488    .73123    .72762    .72405
93............................................................    .74947    .74590    .74236    .73887    .73541
94............................................................    .75922    .75575    .75233    .74893    .74557
95............................................................    .76773    .76436    .76102    .75772    .75445
96............................................................    .77487    .77158    .76832    .76510    .76190
97............................................................    .78125    .77803    .77485    .77169    .76856
98............................................................    .78681    .78365    .78052    .77742    .77435
99............................................................    .79201    .78891    .78583    .78279    .77977
100...........................................................    .79717    .79412    .79111    .78811    .78515
101...........................................................    .80165    .79865    .79568    .79273    .78981
102...........................................................    .80648    .80353    .80060    .79769    .79481
103...........................................................    .81271    .80982    .80695    .80411    .80129
104...........................................................    .81858    .81574    .81292    .81013    .80736
105...........................................................    .83761    .82487    .82214    .81943    .81675
106...........................................................    .84254    .83998    .83743    .83490    .83238
107...........................................................    .86362    .86133    .85906    .85681    .85456
108...........................................................    .89755    .89577    .89401    .89226    .89051
109...........................................................    .95372    .95290    .95208    .95126    .95045
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  11.2%     11.4%     11.6%     11.8%     12.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02630    .02606    .02583    .02562    .02542
1.............................................................    .00827    .00803    .00780    .00759    .00739
2.............................................................    .00789    .00763    .00740    .00718    .00697
3.............................................................    .00787    .00760    .00736    .00712    .00690
4.............................................................    .00802    .00774    .00748    .00723    .00700
5.............................................................    .00832    .00802    .00774    .00748    .00724
6.............................................................    .00873    .00841    .00812    .00784    .00758
7.............................................................    .00921    .00888    .00856    .00827    .00799
8.............................................................    .00979    .00944    .00910    .00879    .00850
9.............................................................    .01049    .01012    .00976    .00943    .00912
10............................................................    .01131    .01091    .01053    .01018    .00985
11............................................................    .01225    .01183    .01143    .01106    .01070
12............................................................    .01331    .01286    .01244    .01205    .01168
13............................................................    .01444    .01397    .01352    .01311    .01271
14............................................................    .01558    .01508    .01461    .01417    .01375
15............................................................    .01667    .01614    .01565    .01519    .01475
16............................................................    .01768    .01713    .01661    .01612    .01566
17............................................................    .01862    .01803    .01749    .01697    .01649
18............................................................    .01949    .01888    .01831    .01776    .01725
19............................................................    .02035    .01971    .01910    .01853    .01799
20............................................................    .02124    .02056    .01992    .01932    .01875
21............................................................    .02217    .02145    .02078    .02014    .01954
22............................................................    .02313    .02238    .02166    .02099    .02035
23............................................................    .02416    .02336    .02261    .02190    .02122
24............................................................    .02529    .02445    .02365    .02290    .02218
25............................................................    .02657    .02568    .02484    .02404    .02328
26............................................................    .02804    .02710    .02620    .02536    .02456
27............................................................    .02970    .02870    .02776    .02686    .02601
28............................................................    .03159    .03053    .02953    .02858    .02768
29............................................................    .03365    .03253    .03147    .03047    .02951
30............................................................    .03591    .03473    .03361    .03255    .03154
31............................................................    .03834    .03709    .03591    .03478    .03372
32............................................................    .04098    .03966    .03841    .03722    .03610
33............................................................    .04383    .04244    .04112    .03987    .03867
34............................................................    .04689    .04543    .04403    .04271    .04145
35............................................................    .05019    .04865    .04718    .04578    .04445
36............................................................    .05372    .05210    .05055    .04907    .04767
37............................................................    .05749    .05578    .05416    .05260    .05112
38............................................................    .06150    .05970    .05799    .05636    .05480
39............................................................    .06575    .06387    .06207    .06035    .05871
40............................................................    .07026    .06828    .06639    .06459    .06286
41............................................................    .07504    .07297    .07099    .06909    .06728
42............................................................    .08013    .07796    .07589    .07390    .07200
43............................................................    .08550    .08323    .08106    .07898    .07699
44............................................................    .09118    .08881    .08654    .08437    .08228
45............................................................    .09714    .09467    .09230    .09003    .08784
46............................................................    .10341    .10084    .09837    .09599    .09371
47............................................................    .10999    .10731    .10473    .10226    .09988
48............................................................    .11693    .11414    .11145    .10888    .10639
49............................................................    .12420    .12130    .11852    .11583    .11325
50............................................................    .13185    .12884    .12595    .12316    .12047
51............................................................    .13985    .13674    .13373    .13084    .12805
52............................................................    .14822    .14499    .14188    .13888    .13598
53............................................................    .15695    .15361    .15039    .14729    .14428
54............................................................    .16601    .16256    .15924    .15602    .15292
55............................................................    .17542    .17186    .16843    .16511    .16190
56............................................................    .18516    .18150    .17796    .17454    .17122
57............................................................    .19527    .19150    .18786    .18433    .18091
58............................................................    .20573    .20186    .19811    .19448    .19096
59............................................................    .21659    .21262    .20877    .20504    .20142
60............................................................    .22784    .22377    .21982    .21599    .21227
61............................................................    .23952    .23535    .23131    .22738    .22357
62............................................................    .25163    .24737    .24324    .23922    .23531
63............................................................    .26418    .25984    .25561    .25151    .24751
64............................................................    .27716    .27273    .26842    .26423    .26015
65............................................................    .29054    .28604    .28165    .27738    .27322
66............................................................    .30434    .29976    .29530    .29096    .28672
67............................................................    .31852    .31388    .30935    .30494    .30063
68............................................................    .33310    .32840    .32381    .31933    .31496
69............................................................    .34809    .34334    .33870    .33417    .32975
70............................................................    .36353    .35874    .35405    .34948    .34500
71............................................................    .37948    .37466    .36994    .36532    .36081
72............................................................    .39595    .39111    .38636    .38172    .37718
73............................................................    .41286    .40801    .40325    .39859    .39403
74............................................................    .43004    .42518    .42042    .41575    .41118
75............................................................    .44730    .44245    .43770    .43304    .42846
76............................................................    .46457    .45974    .45500    .45035    .44579
77............................................................    .48181    .47700    .47229    .46766    .46311
78............................................................    .49903    .49426    .48958    .48497    .48045
79............................................................    .51631    .51159    .50694    .50238    .49789
80............................................................    .53371    .52905    .52446    .51994    .51550
81............................................................    .55110    .54650    .54197    .53752    .53313
82............................................................    .56835    .56382    .55937    .55497    .55065
83............................................................    .58546    .58101    .57663    .57231    .56806

[[Page 70]]

                                                                                                                
84............................................................    .60253    .59817    .59388    .58965    .58547
85............................................................    .61961    .61536    .61116    .60703    .60294
86............................................................    .63630    .63215    .62806    .62402    .62004
87............................................................    .65203    .64800    .64401    .64007    .63619
88............................................................    .66676    .66282    .65894    .65510    .65131
89............................................................    .68079    .67696    .67318    .66944    .66574
90............................................................    .69455    .69084    .68716    .68353    .67993
91............................................................    .70795    .70435    .70078    .69726    .69377
92............................................................    .72052    .71703    .71357    .71015    .70677
93............................................................    .73198    .72860    .72524    .72192    .71864
94............................................................    .74225    .73896    .73570    .73248    .72928
95............................................................    .75121    .74801    .74483    .74169    .73858
96............................................................    .75874    .75561    .75250    .74943    .74639
97............................................................    .76546    .76240    .75936    .75635    .75336
98............................................................    .77131    .76830    .76531    .76235    .75942
99............................................................    .77678    .77382    .77088    .76798    .76509
100...........................................................    .78221    .77930    .77642    .77356    .77072
101...........................................................    .78691    .78404    .78119    .77837    .77557
102...........................................................    .79196    .78912    .78632    .78353    .78077
103...........................................................    .79849    .79572    .79297    .79024    .78753
104...........................................................    .80460    .80188    .79917    .79648    .79381
105...........................................................    .81408    .81143    .80881    .80620    .80361
106...........................................................    .82989    .82740    .82494    .82249    .82006
107...........................................................    .85233    .85012    .84791    .84572    .84353
108...........................................................    .88877    .88704    .88532    .88361    .88190
109...........................................................    .94964    .94883    .94803    .94723    .94643
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  12.2%     12.4%     12.6%     12.8%     13.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02523    .02505    .02488    .02472    .02456
1.............................................................    .00721    .00703    .00687    .00671    .00657
2.............................................................    .00678    .00659    .00642    .00626    .00610
3.............................................................    .00670    .00650    .00632    .00615    .00599
4.............................................................    .00678    .00658    .00638    .00620    .00603
5.............................................................    .00701    .00679    .00658    .00639    .00620
6.............................................................    .00733    .00710    .00688    .00668    .00648
7.............................................................    .00733    .00748    .00725    .00703    .00682
8.............................................................    .00822    .00796    .00771    .00748    .00726
9.............................................................    .00882    .00854    .00828    .00803    .00780
10............................................................    .00953    .00924    .00896    .00869    .00844
11............................................................    .01037    .01006    .00976    .00948    .00922
12............................................................    .01132    .01099    .01068    .01038    .01010
13............................................................    .01234    .01199    .01166    .01134    .01104
14............................................................    .01336    .01299    .01264    .01231    .01199
15............................................................    .01434    .01395    .01358    .01323    .01289
16............................................................    .01522    .01481    .01442    .01405    .01371
17............................................................    .01603    .01559    .01518    .01480    .01443
18............................................................    .01677    .01631    .01588    .01547    .01508
19............................................................    .01748    .01700    .01654    .01611    .01570
20............................................................    .01821    .01770    .01722    .01677    .01633
21............................................................    .01897    .01843    .01792    .01744    .01698
22............................................................    .01975    .01918    .01864    .01813    .01765
23............................................................    .02059    .01998    .01941    .01887    .01836
24............................................................    .02151    .02087    .02027    .01970    .01915
25............................................................    .02257    .02189    .02125    .02064    .02006
26............................................................    .02380    .02308    .02240    .02175    .02114
27............................................................    .02521    .02445    .02373    .02304    .02239
28............................................................    .02683    .02602    .02525    .02452    .02383
29............................................................    .02861    .02775    .02694    .02616    .02543
30............................................................    .03058    .02967    .02881    .02798    .02720
31............................................................    .03270    .03174    .03082    .02995    .02911
32............................................................    .03502    .03400    .03303    .03210    .03122
33............................................................    .03754    .03646    .03543    .03444    .03350
34............................................................    .04025    .03910    .03801    .03697    .03597
35............................................................    .04318    .04197    .04081    .03971    .03865
36............................................................    .04633    .04505    .04383    .04266    .04154
37............................................................    .04971    .04836    .04707    .04583    .04465
38............................................................    .05331    .05188    .05052    .04922    .04797
39............................................................    .05714    .05564    .05420    .05282    .05150
40............................................................    .06121    .05963    .05812    .05667    .05528
41............................................................    .06554    .06388    .06229    .06076    .05929
42............................................................    .07018    .06843    .06675    .06514    .06360
43............................................................    .07508    .07324    .07148    .06979    .06817
44............................................................    .08028    .07325    .07651    .07473    .07303
45............................................................    .08575    .08373    .08180    .07993    .07814
46............................................................    .09152    .08941    .08738    .08543    .08355
47............................................................    .09759    .09539    .09326    .09122    .08926
48............................................................    .10401    .10171    .09949    .09735    .09530
49............................................................    .11076    .10836    .10605    .10382    .10167
50............................................................    .11788    .11538    .11297    .11065    .10840
51............................................................    .12535    .12276    .12025    .11782    .11548
52............................................................    .13319    .13049    .12788    .12536    .12292
53............................................................    .14139    .13858    .13588    .13326    .13072
54............................................................    .14992    .14701    .14420    .14149    .13885
55............................................................    .15880    .15579    .15288    .15006    .14733
56............................................................    .16801    .16491    .16190    .15898    .15615
57............................................................    .17760    .17439    .17128    .16827    .16534
58............................................................    .18755    .18424    .18103    .17792    .17489
59............................................................    .19790    .19450    .19119    .18798    .18486
60............................................................    .20866    .20516    .20175    .19844    .19523
61............................................................    .21986    .21626    .21276    .20936    .20605
62............................................................    .23151    .22782    .22423    .22073    .21733
63............................................................    .24362    .23984    .23616    .23257    .22908
64............................................................    .25617    .25231    .24854    .24487    .24129
65............................................................    .26917    .26522    .26137    .25761    .25395
66............................................................    .28259    .27857    .27464    .27081    .26707
67............................................................    .29643    .29233    .28833    .28443    .38061
68............................................................    .31070    .30653    .30246    .29849    .29461
69............................................................    .32542    .32120    .31707    .31303    .30908
70............................................................    .34063    .33635    .33217    .32807    .32407
71............................................................    .35639    .35207    .34784    .34370    .33965
72............................................................    .37273    .36837    .36410    .35993    .35583
73............................................................    .38955    .38517    .38088    .37667    .37255
74............................................................    .40670    .40230    .39799    .39377    .38962
75............................................................    .42398    .41958    .41526    .41102    .40686
76............................................................    .44131    .43691    .43259    .42825    .42419
77............................................................    .45864    .45425    .44994    .44571    .44155
78............................................................    .47601    .47164    .46734    .46312    .45897
79............................................................    .49348    .48914    .48487    .48067    .47654
80............................................................    .51112    .50682    .50259    .49842    .49432
81............................................................    .52881    .52455    .52036    .51624    .51218
82............................................................    .54639    .54219    .53805    .53398    .52996
83............................................................    .56386    .55973    .55566    .55164    .54768
84............................................................    .58136    .57730    .57329    .56934    .56545
85............................................................    .59891    .59494    .59102    .58715    .58333
86............................................................    .61610    .61222    .60839    .60460    .60086
87............................................................    .62335    .62856    .62481    .62111    .61746
88............................................................    .64757    .64386    .64021    .63659    .63302
89............................................................    .66209    .65848    .65491    .65139    .64790
90............................................................    .67638    .67287    .66939    .66596    .66256
91............................................................    .69032    .68691    .68353    .68019    .67689
92............................................................    .70342    .70011    .69683    .69359    .69038

[[Page 71]]

                                                                                                                
93............................................................    .71539    .71217    .70899    .70584    .70271
94............................................................    .72612    .72299    .71989    .71683    .71379
95............................................................    .73550    .43245    .72943    .72643    .72347
96............................................................    .74337    .74039    .73743    .73450    .73160
97............................................................    .75041    .74748    .74458    .74171    .73886
98............................................................    .74652    .75364    .75079    .74797    .74517
99............................................................    .76224    .75941    .75660    .75382    .75106
100...........................................................    .76791    .76513    .76237    .75963    .75692
101...........................................................    .77280    .77005    .76732    .67462    .76194
102...........................................................    .77804    .77532    .77263    .76996    .76732
103...........................................................    .78485    .78218    .77954    .77692    .77432
104...........................................................    .79117    .78854    .78594    .78335    .78078
105...........................................................    .80103    .79848    .78595    .79343    .79093
106...........................................................    .81764    .81524    .81285    .81048    .80813
107...........................................................    .84137    .93921    .83706    .83493    .83281
108...........................................................    .88020    .87851    .87682    .87515    .87348
109...........................................................    .94563    .94484    .94405    .94326    .94248
----------------------------------------------------------------------------------------------------------------


                                                     Table G                                                    
 Table G--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Pooled Income Fund Having the Yearly Rate of Return Shown--Applicable for Transfers After November 30,  
                                          1983, and Before May 1, 1989                                          
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Yearly rate of return           
                            (1) Age                            -------------------------------------------------
                                                                  13.2%     13.4%     13.6%     13.8%     14.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02442    .02428    .02414    .02402    .02389
1.............................................................    .00643    .00629    .00617    .00605    .00594
2.............................................................    .00596    .00582    .00569    .00556    .00544
3.............................................................    .00583    .00569    .00555    .00542    .00529
4.............................................................    .00586    .00571    .00556    .00542    .00529
5.............................................................    .00603    .00587    .00571    .00556    .00542
6.............................................................    .00630    .00612    .00595    .00580    .00565
7.............................................................    .00663    .00644    .00626    .00610    .00594
8.............................................................    .00705    .00685    .00666    .00648    .00631
9.............................................................    .00757    .00736    .00716    .00697    .00679
10............................................................    .00821    .00798    .00777    .00756    .00737
11............................................................    .00896    .00872    .00850    .00828    .00807
12............................................................    .00983    .00958    .00934    .00911    .00889
13............................................................    .01076    .01049    .01024    .00999    .00976
14............................................................    .01170    .01141    .01114    .01088    .01064
15............................................................    .01258    .01228    .01200    .01172    .01147
16............................................................    .01337    .01306    .01276    .01247    .01220
17............................................................    .01408    .01375    .01343    .01313    .01284
18............................................................    .01471    .01436    .01403    .01371    .01341
19............................................................    .01531    .01494    .01459    .01426    .01394
20............................................................    .01592    .01553    .01516    .01481    .01447
21............................................................    .01655    .01614    .01574    .01537    .01502
22............................................................    .01719    .01675    .01634    .01594    .01557
23............................................................    .01787    .01741    .01697    .01655    .01615
24............................................................    .01863    .01814    .01768    .01723    .01681
25............................................................    .01952    .01899    .01850    .01802    .01757
26............................................................    .02056    .02000    .01947    .01897    .01849
27............................................................    .02177    .02118    .02061    .02008    .01956
28............................................................    .02317    .02254    .02194    .02137    .02082
29............................................................    .02472    .02405    .02342    .02281    .02223
30............................................................    .02645    .02574    .02506    .02441    .02379
31............................................................    .02832    .02756    .02684    .02615    .02549
32............................................................    .03037    .02957    .02880    .02806    .02736
33............................................................    .03261    .03175    .03093    .03015    .02940
34............................................................    .03502    .03411    .03324    .03241    .03162
35............................................................    .03764    .03668    .03576    .03488    .03403
36............................................................    .04048    .03945    .03847    .03754    .03664
37............................................................    .04352    .04244    .04140    .04040    .03945
38............................................................    .04677    .04563    .04453    .04347    .04246
39............................................................    .05024    .04903    .04787    .04675    .04568
40............................................................    .05394    .05266    .05143    .05025    .04912
41............................................................    .05789    .05653    .05524    .05399    .05279
42............................................................    .06212    .06069    .05932    .05800    .05674
43............................................................    .06661    .06511    .06366    .06227    .06093
44............................................................    .07138    .06980    .06828    .06682    .06541
45............................................................    .07642    .07476    .07316    .07162    .07013
46............................................................    .08174    .08000    .07832    .07670    .07514
47............................................................    .08736    .08553    .08377    .08207    .08042
48............................................................    .09331    .09140    .08955    .08776    .08604
49............................................................    .09959    .09759    .09565    .09378    .09198
50............................................................    .10624    .10414    .10212    .10016    .09827
51............................................................    .11322    .11104    .10892    .10688    .10490
52............................................................    .12057    .11829    .11608    .11395    .11188
53............................................................    .12827    .12590    .12360    .12138    .11922
54............................................................    .13631    .13384    .13145    .12913    .12689
55............................................................    .14469    .14213    .13964    .13724    .13490
56............................................................    .15341    .15075    .14817    .14567    .14324
57............................................................    .16250    .15975    .15708    .15448    .15196
58............................................................    .17196    .16911    .16634    .16365    .16104
59............................................................    .18183    .17888    .17602    .17324    .17053
60............................................................    .19210    .18906    .18611    .18323    .18043
61............................................................    .20283    .19970    .19665    .19368    .19079
62............................................................    .21402    .21079    .20766    .20460    .20162
63............................................................    .22568    .22237    .21914    .21600    .21293
64............................................................    .23780    .23440    .23109    .22786    .22471
65............................................................    .25038    .24690    .24350    .24019    .23695
66............................................................    .26342    .25986    .25638    .25298    .24967
67............................................................    .27689    .27325    .26970    .26623    .26284
68............................................................    .29081    .28711    .28248    .27994    .27647
69............................................................    .30523    .30145    .29776    .29415    .29062
70............................................................    .32015    .31632    .31257    .30890    .30530
71............................................................    .33568    .33179    .32799    .32426    .32061
72............................................................    .35182    .34789    .34404    .34027    .33657
73............................................................    .36851    .36455    .36066    .35685    .35311
74............................................................    .38555    .38156    .37765    .37381    .37004
75............................................................    .40278    .39877    .39484    .39098    .38710
76............................................................    .42010    .41608    .41213    .40826    .40445
77............................................................    .43746    .43344    .42949    .42561    .42179
78............................................................    .45489    .45088    .44693    .44305    .43923
79............................................................    .47248    .46848    .46454    .46067    .45686
80............................................................    .49028    .48631    .48240    .47854    .47475
82............................................................    .50818    .50423    .50035    .49653    .59276
82............................................................    .52600    .52210    .51826    .51447    .51074
83............................................................    .54377    .53992    .53613    .53238    .52869
84............................................................    .56160    .55781    .55407    .55038    .54674
85............................................................    .57956    .57584    .57216    .56854    .56496
86............................................................    .59717    .59353    .58993    .58638    .58287
87............................................................    .61385    .61028    .60676    .60328    .59984
88............................................................    .62950    .62601    .62256    .61915    .61578
89............................................................    .64445    .64104    .63767    .63434    .63105
90............................................................    .65920    .65588    .65259    .64934    .64612
91............................................................    .67362    .67039    .66719    .66402    .66089
92............................................................    .68720    .68405    .68094    .67786    .67481
93............................................................    .69962    .69657    .69354    .69054    .68757
94............................................................    .71078    .70780    .70485    .70193    .69903
95............................................................    .72053    .71763    .71475    .71189    .70906
96............................................................    .72872    .72587    .72305    .72026    .71748
97............................................................    .73604    .73325    .73048    .72773    .72501
98............................................................    .74239    .73964    .73692    .73422    .73154
99............................................................    .74833    .74562    .74294    .74028    .73764
100...........................................................    .75423    .75156    .74892    .74630    .74370
101...........................................................    .75928    .75664    .75403    .75144    .74887

[[Page 72]]

                                                                                                                
102...........................................................    .76469    .76209    .75950    .75694    .75440
103...........................................................    .77174    .76918    .76664    .76413    .76163
104...........................................................    .77824    .77571    .77320    .77071    .76824
105...........................................................    .78845    .78599    .78354    .78111    .77870
106...........................................................    .80579    .80346    .80115    .79885    .79657
107...........................................................    .83070    .82860    .82652    .82444    .82238
108...........................................................    .87182    .87016    .86852    .86688    .86525
109...........................................................    .94170    .94092    .94014    .93937    .93860
----------------------------------------------------------------------------------------------------------------


[Redesignated from 36 FR 6480, Apr. 6, 1971. T.D. 8540, 59 FR 30102, 
30105, 30116, June 10, 1994]

               trusts which distribute current income only



Sec. 1.651(a)-1   Simple trusts; deduction for distributions; in general.

    Section 651 is applicable only to a trust the governing instruments 
of which:
    (a) Requires that the trust distribute all of its income currently 
for the taxable year, and
    (b) Does not provide that any amounts may be paid, permanently set 
aside, or used in the taxable year for the charitable, etc., purposes 
specified in section 642(c),

and does not make any distribution other than of current income. A trust 
to which section 651 applies is referred to in this part as a ``simple'' 
trust. Trusts subject to section 661 are referred to as ``complex'' 
trusts. A trust may be a simple trust for one year and a complex trust 
for another year. It should be noted that under section 651 a trust 
qualifies as a simple trust in a taxable year in which it is required to 
distribute all its income currently and makes no other distributions, 
whether or not distributions of current income are in fact made. On the 
other hand a trust is not a complex trust by reason of distributions of 
amounts other than income unless such distributions are in fact made 
during the taxable year, whether or not they are required in that year.



Sec. 1.651(a)-2  Income required to be distributed currently.

    (a) The determination of whether trust income is required to be 
distributed currently depends upon the terms of the trust instrument and 
the applicable local law. For this purpose, if the trust instrument 
provides that the trustee in determining the distributable income shall 
first retain a reserve for depreciation or otherwise make due allowance 
for keeping the trust corpus intact by retaining a reasonable amount of 
the current income for that purpose, the retention of current income for 
that purpose will not disqualify the trust from being a ``simple'' 
trust. The fiduciary must be under a duty to distribute the income 
currently even if, as a matter of practical necessity, the income is not 
distributed until after the close of the trust's taxable year. For 
example: Under the terms of the trust instrument, all of the income is 
currently distributable to A. The trust reports on the calendar year 
basis and as a matter of practical necessity makes distribution to A of 
each quarter's income on the fifteenth day of the month following the 
close of the quarter. The distribution made by the trust on January 15, 
1955, of the income for the fourth quarter of 1954 does not disqualify 
the trust from treatment in 1955 under section 651, since the income is 
required to be distributed currently. However, if the terms of a trust 
require that none of the income be distributed until after the year of 
its receipt by the trust, the income of the trust is not required to be 
distributed currently and the trust is not a simple trust. For 
definition of the term ``income'' see section 643(b) and Sec. 1.643(b)-
1.
    (b) It is immaterial, for purposes of determining whether all the 
income is required to be distributed currently, that the amount of 
income allocated to a particular beneficiary is not specified in the 
instrument. For example, if the fiduciary is required to distribute all 
the income currently, but has discretion to ``sprinkle'' the income 
among a class of beneficiaries, or among named beneficiaries, in such 
amount as he may see fit, all the income is required to be distributed 
currently, even though the amount distributable to a

[[Page 73]]

particular beneficiary is unknown until the fiduciary has exercised his 
discretion.
    (c) If in one taxable year of a trust its income for that year is 
required or permitted to be accumulated, and in another taxable year its 
income for the year is required to be distributed currently (and no 
other amounts are distributed), the trust is a simple trust for the 
latter year. For example, a trust under which income may be accumulated 
until a beneficiary is 21 years old, and thereafter must be distributed 
currently, is a simple trust for taxable years beginning after the 
beneficiary reaches the age of 21 years in which no other amounts are 
distributed.



Sec. 1.651(a)-3   Distribution of amounts other than income.

    (a) A trust does not qualify for treatment under section 651 for any 
taxable year in which it actually distributes corpus. For example, a 
trust which is required to distribute all of its income currently would 
not qualify as a simple trust under section 651 in the year of its 
termination since in that year actual distributions of corpus would be 
made.
    (b) A trust, otherwise qualifying under section 651, which may make 
a distribution of corpus in the discretion of the trustee, or which is 
required under the terms of its governing instrument to make a 
distribution of corpus upon the happening of a specified event, will be 
disqualified for treatment under section 651 only for the taxable year 
in which an actual distribution of corpus is made. For example: Under 
the terms of a trust, which is required to distribute all of its income 
currently, half of the corpus is to be distributed to beneficiary A when 
he becomes 30 years of age. The trust reports on the calendar year 
basis. On December 28, 1954, A becomes 30 years of age and the trustee 
distributes half of the corpus of the trust to him on January 3, 1955. 
The trust will be disqualified for treatment under section 651 only for 
the taxable year 1955, the year in which an actual distribution of 
corpus is made.
    (c) See section 661 and the regulations thereunder for the treatment 
of trusts which distribute corpus or claim the charitable contributions 
deduction provided by section 642(c).



Sec. 1.651(a)-4   Charitable purposes.

    A trust is not considered to be a trust which may pay, permanently 
set aside, or use any amount for charitable, etc., purposes for any 
taxable year for which it is not allowed a charitable, etc., deduction 
under section 642(c). Therefore, a trust with a remainder to a 
charitable organization is not disqualified for treatment as a simple 
trust if either (a) the remainder is subject to a contingency, so that 
no deduction would be allowed for capital gains or other amounts added 
to corpus as amounts permanently set aside for a charitable, etc., 
purpose under section 642 (c), or (b) the trust receives no capital 
gains or other income added to corpus for the taxable year for which 
such a deduction would be allowed.



Sec. 1.651(a)-5   Estates.

    Subpart B has no application to an estate.



Sec. 1.651(b)-1   Deduction for distributions to beneficiaries.

    In computing its taxable income, a simple trust is allowed a 
deduction for the amount of income which is required under the terms of 
the trust instrument to be distributed currently to beneficiaries. If 
the amount of income required to be distributed currently exceeds the 
distributable net income, the deduction allowable to the trust is 
limited to the amount of the distributable net income. For this purpose 
the amount of income required to be distributed currently, or 
distributable net income, whichever is applicable, does not include 
items of trust income (adjusted for deductions allocable thereto) which 
are not included in the gross income of the trust. For determination of 
the character of the income required to be distributed currently, see 
Sec. 1.652(b)-2. Accordingly, for the purposes of determining the 
deduction allowable to the trust under section 651, distributable net 
income is computed without the modifications specified in paragraphs 
(5), (6), and (7) of section 643(a), relating to tax-exempt interest, 
foreign income, and excluded dividends. For example: Assume that the 
distributable

[[Page 74]]

net income of a trust as computed under section 643(a) amounts to 
$99,000 but includes nontaxable income of $9,000. Then distributable net 
income for the purpose of determining the deduction allowable under 
section 651 is $90,000 ($99,000 less $9,000 nontaxable income).



Sec. 1.652(a)-1   Simple trusts; inclusion of amounts in income of beneficiaries.

    Subject to the rules in Secs. 1.652(a)-2 and 1.652(b)-1, a 
beneficiary of a simple trust includes in his gross income for the 
taxable year the amounts of income required to be distributed to him for 
such year, whether or not distributed. Thus, the income of a simple 
trust is includible in the beneficiary's gross income for the taxable 
year in which the income is required to be distributed currently even 
though, as a matter of practical necessity, the income is not 
distributed until after the close of the taxable year of the trust. See 
Sec. 1.642(a)(3)-2 with respect to time of receipt of dividends. See 
Sec. 1.652(c)-1 for treatment of amounts required to be distributed 
where a beneficiary and the trust have different taxable years. The term 
income required to be distributed currently includes income required to 
be distributed currently which is in fact used to discharge or satisfy 
any person's legal obligation as that term is used in Sec. 1.662(a)-4.



Sec. 1.652(a)-2   Distributions in excess of distributable net income.

    If the amount of income required to be distributed currently to 
beneficiaries exceeds the distributable net income of the trust (as 
defined in section 643(a)), each beneficiary includes in his gross 
income an amount equivalent to his proportionate share of such 
distributable net income. Thus, if beneficiary A is to receive two-
thirds of the trust income and B is to receive one-third, and the income 
required to be distributed currently is $99,000, A will receive $66,000 
and B, $33,000. However, if the distributable net income, as determined 
under section 643(a) is only $90,000, A will include two-thirds 
($60,000) of that sum in his gross income, and B will include one-third 
($30,000) in his gross income. See Secs. 1.652(b)-1 and 1.652(b)-2, 
however, for amounts which are not includible in the gross income of a 
beneficiary because of their tax-exempt character.



Sec. 1.652(b)-1   Character of amounts.

    In determining the gross income of a beneficiary, the amounts 
includible under Sec. 1.652(a)-1 have the same character in the hands of 
the beneficiary as in the hands of the trust. For example, to the extent 
that the amounts specified in Sec. 1.652(a)-1 consist of income exempt 
from tax under section 103, such amounts are not included in the 
beneficiary's gross income. Similarly, dividends distributed to a 
beneficiary retain their original character in the beneficiary's hands 
for purposes of determining the availability to the beneficiary of the 
dividends received credit under section 34 (for dividends received on or 
before December 31, 1964) and the dividend exclusion under section 116. 
Also, to the extent that the amounts specified in Sec. 1.652(a)-1 
consist of ``earned income'' in the hands of the trust under the 
provisions of section 1348 such amount shall be treated under section 
1348 as ``earned income'' in the hands of the beneficiary. Similarly, to 
the extent such amounts consist of an amount received as a part of a 
lump sum distribution from a qualified plan and to which the provisions 
of section 72(n) would apply in the hands of the trust, such amount 
shall be treated as subject to such section in the hands of the 
beneficiary except where such amount is deemed under section 666(a) to 
have been distributed in a preceding taxable year of the trust and the 
partial tax described in section 668(a)(2) is determined under section 
668(b)(1)(B). The tax treatment of amounts determined under 
Sec. 1.652(a)-1 depends upon the beneficiary's status with respect to 
them not upon the status of the trust. Thus, if a beneficiary is deemed 
to have received foreign income of a foreign trust, the includibility of 
such income in his gross income depends upon his taxable status with 
respect to that income.

[T.D. 7204, 37 FR 17134, Aug. 25, 1972]

[[Page 75]]



Sec. 1.652(b)-2   Allocation of income items.

    (a) The amounts specified in Sec. 1.652(a)-1 which are required to 
be included in the gross income of a beneficiary are treated as 
consisting of the same proportion of each class of items entering into 
distributable net income of the trust (as defined in section 643(a)) as 
the total of each class bears to such distributable net income, unless 
the terms of the trust specifically allocate different classes of income 
to different beneficiaries, or unless local law requires such an 
allocation. For example: Assume that under the terms of the governing 
instrument, beneficiary A is to receive currently one-half of the trust 
income and beneficiaries B and C are each to receive currently one-
quarter, and the distributable net income of the trust (after allocation 
of expenses) consists of dividends of $10,000, taxable interest of 
$10,000, and tax-exempt interest of $4,000. A will be deemed to have 
received $5,000 of dividends, $5,000 of taxable interest, and $2,000 of 
tax-exempt interest; B and C will each be deemed to have received $2,500 
of dividends, $2,500 of taxable interest, and $1,000 of tax-exempt 
interest. However, if the terms of the trust specifically allocate 
different classes of income to different beneficiaries, entirely or in 
part, or if local law requires such an allocation, each beneficiary will 
be deemed to have received those items of income specifically allocated 
to him.
    (b) The terms of the trust are considered specifically to allocate 
different classes of income to different beneficiaries only to the 
extent that the allocation is required in the trust instrument, and only 
to the extent that it has an economic effect independent of the income 
tax consequences of the allocation. For example:
    (1) Allocation pursuant to a provision in a trust instrument 
granting the trustee discretion to allocate different classes of income 
to different beneficiaries is not a specific allocation by the terms of 
the trust.
    (2) Allocation pursuant to a provision directing the trustee to pay 
all of one income to A, or $10,000 out of the income to A, and the 
balance of the income to B, but directing the trustee first to allocate 
a specific class of income to A's share (to the extent there is income 
of that class and to the extent it does not exceed A's share) is not a 
specific allocation by the terms of the trust.
    (3) Allocation pursuant to a provision directing the trustee to pay 
half the class of income (whatever it may be) to A, and the balance of 
the income to B, is a specific allocation by the terms of the trust.



Sec. 1.652(b)-3   Allocation of deductions.

    Items of deduction of a trust that enter into the computation of 
distributable net income are to be allocated among the items of income 
in accordance with the following principles:
    (a) All deductible items directly attributable to one class of 
income (except dividends excluded under section 116) are allocated 
thereto. For example, repairs to, taxes on, and other expenses directly 
attributable to the maintenance of rental property or the collection of 
rental income are allocated to rental income. See Sec. 1.642(e)-1 for 
treatment of depreciation of rental property. Similarly, all 
expenditures directly attributable to a business carried on by a trust 
are allocated to the income from such business. If the deductions 
directly attributable to a particular class of income exceed that 
income, the excess is applied against other classes of income in the 
manner provided in paragraph (d) of this section.
    (b) The deductions which are not directly attributable to a specific 
class of income may be allocated to any item of income (including 
capital gains) included in computing distributable net income, but a 
portion must be allocated to nontaxable income (except dividends 
excluded under section 116) pursuant to section 265 and the regulations 
thereunder. For example, if the income of a trust is $30,000 (after 
direct expenses), consisting equally of $10,000 of dividends, tax-exempt 
interest, and rents, and income commissions amount to $3,000, one-third 
($1,000) of such commissions should be allocated to tax-exempt interest, 
but the balance of $2,000 may be allocated to the rents or dividends in 
such proportions as the trustee may elect. The fact that the governing 
instrument or applicable local law

[[Page 76]]

treats certain items of deduction as attributable to corpus or to income 
not included in distributable net income does not affect allocation 
under this paragraph. For instance, if in the example set forth in this 
paragraph the trust also had capital gains which are allocable to corpus 
under the terms of the trust instrument, no part of the deductions would 
be allocable thereto since the capital gains are excluded from the 
computation of distributable net income under section 643(a)(3).
    (c) Examples of expenses which are considered as not directly 
attributable to a specific class of income are trustee's commissions, 
the rental of safe deposit boxes, and State income and personal property 
taxes.
    (d) To the extent that any items of deduction which are directly 
attributable to a class of income exceed that class of income, they may 
be allocated to any other class of income (including capital gains) 
included in distributable net income in the manner provided in paragraph 
(b) of this section, except that any excess deductions attributable to 
tax-exempt income (other than dividends excluded under section 116) may 
not be offset against any other class of income. See section 265 and the 
regulations thereunder. Thus, if the trust has rents, taxable interest, 
dividends, and tax-exempt interest, and the deductions directly 
attributable to the rents exceed the rental income, the excess may be 
allocated to the taxable interest or dividends in such proportions as 
the fiduciary may elect. However, if the excess deductions are 
attributable to the tax-exempt interest, they may not be allocated to 
either the rents, taxable interest, or dividends.



Sec. 1.652(c)-1   Different taxable years.

    If a beneficiary has a different taxable year (as defined in section 
441 or 442) from the taxable year of the trust, the amount he is 
required to include in gross income in accordance with section 652 (a) 
and (b) is based on the income of the trust for any taxable year or 
years ending with or within his taxable year. This rule applies to 
taxable years of normal duration as well as to so-called short taxable 
years. Income of the trust for its taxable year or years is determined 
in accordance with its method of accounting and without regard to that 
of the beneficiary.



Sec. 1.652(c)-2   Death of individual beneficiaries.

    If income is required to be distributed currently to a beneficiary, 
by a trust for a taxable year which does not end with or within the last 
taxable year of a beneficiary (because of the beneficiary's death), the 
extent to which the income is included in the gross income of the 
beneficiary for his last taxable year or in the gross income of his 
estate is determined by the computations under section 652 for the 
taxable year of the trust in which his last taxable year ends. Thus, the 
distributable net income of the taxable year of the trust determines the 
extent to which the income required to be distributed currently to the 
beneficiary is included in his gross income for his last taxable year or 
in the gross income of his estate. (Section 652(c) does not apply to 
such amounts.) The gross income for the last taxable year of a 
beneficiary on the cash basis includes only income actually distributed 
to the beneficiary before his death. Income required to be distributed, 
but in fact distributed to his estate, is included in the gross income 
of the estate as income in respect of a decedent under section 691. See 
paragraph (e) of Sec. 1.663(c)-3 with respect to separate share 
treatment for the periods before and after the decedent's death. If the 
trust does not qualify as a simple trust for the taxable year of the 
trust in which the last taxable year of the beneficiary ends, see 
section 662(c) and Sec. 1.662(c)-2.



Sec. 1.652(c)-3   Termination of existence of other beneficiaries.

    If the existence of a beneficiary which is not an individual 
terminates, the amount to be included under section 652(a) in its gross 
income for its last taxable year is computed with reference to 
Secs. 1.652(c)-1 and 1.652(c)-2 as if the beneficiary were a deceased 
individual, except that income required to be distributed prior to the 
termination but actually distributed to the beneficiary's successor in 
interest is included in the beneficiary's income for its last taxable 
year.

[[Page 77]]



Sec. 1.652(c)-4   Illustration of the provisions of sections 651 and 652.

    The rules applicable to a trust required to distribute all of its 
income currently to its beneficiaries may be illustrated by the 
following example:

    Example. (a) Under the terms of a simple trust all of the income is 
to be distributed equally to beneficiaries A and B and capital gains are 
to be allocated to corpus. The trust and both beneficiaries file returns 
on the calendar year basis. No provision is made in the governing 
instrument with respect to depreciation. During the taxable year 1955, 
the trust had the following items of income and expense:

Rents........................................................    $25,000
Dividends of domestic corporations...........................     50,000
Tax-exempt interest on municipal bonds.......................     25,000
Long-term capital gains......................................     15,000
Taxes and expenses directly attributable to rents............      5,000
Trustee's commissions allocable to income account............      2,600
Trustee's commissions allocable to principal account.........      1,300
Depreciation.................................................      5,000
                                                                        

    (b) The income of the trust for fiduciary accounting purposes is 
$92,400, computed as follows:

Rents........................................................    $25,000
Dividends....................................................     50,000
Tax-exempt interest..........................................     25,000
                                                   ------------         
    Total....................................................    100,000
Deductions:                                                             
  Expenses directly attributable to rental income.     $5,000           
  Trustee's commissions allocable to income                             
   account........................................      2,600           
                                                   -----------          
                                                                   7,600
                                                   ------------         
    Income computed under section 643(b).....................     92,400
                                                                        

One-half ($46,200) of the income of $92,400 is currently distributable 
to each beneficiary.
    (c) The distributable net income of the trust computed under section 
643(a) is $91,100, determined as follows (cents are disregarded in the 
computation):

Rents........................................................    $25,000
Dividends....................................................     50,000
Tax-exempt interest...............................    $25,000           
Less: Expenses allocable thereto (25,000/100,000                        
 x $3,900)........................................        975           
                                                     --------     24,025
                                                              ----------
    Total.........................................  .........     99,025
Deductions:                                                             
  Expenses directly attributable to rental income.     $5,000           
  Trustee's commissions ($3,900 less $975                               
   allocable to tax-exempt interest)..............      2,925           
                                                     --------      7,925
                                                              ----------
    Distributable net income......................  .........     91,100
                                                                        

In computing the distributable net income of $91,100, the taxable income 
of the trust was computed with the following modifications: No 
deductions were allowed for distributions to the beneficiaries and for 
personal exemption of the trust (section 643(a) (1) and (2)); capital 
gains were excluded and no deduction under section 1202 (relating to the 
50-percent deduction for long-term capital gains) was taken into account 
(section 643(a)(3)); the tax-exempt interest (as adjusted for expenses) 
and the dividend exclusion of $50 were included (section 643(a) (5) and 
(7)). Since all of the income of the trust is required to be currently 
distributed, no deduction is allowable for depreciation in the absence 
of specific provisions in the governing instrument providing for the 
keeping of the trust corpus intact. See section 167(h) and the 
regulations thereunder.
    (d) The deduction allowable to the trust under section 651(a) for 
distributions to the beneficiaries is $67,025, computed as follows:

Distributable net income computed under section 643(a) (see             
 paragraph (c))..............................................    $91,100
Less:                                                                   
  Tax-exempt interest as adjusted.................    $24,025           
  Dividend exclusion..............................         50           
                                                     --------     24,075
                                                              ----------
    Distributable net income as determined under section                
     651(b)..................................................     67,025
                                                                        

Since the amount of the income ($92,400) required to be distributed 
currently by the trust exceeds the distributable net income ($67,025) as 
computed under section 651(b), the deduction allowable under section 
651(a) is limited to the distributable net income of $67,025.
    (e) The taxable income of the trust is $7,200 computed as follows:

Rents........................................................    $25,000
Dividends ($50,000 less $50 exclusion).......................     49,950
Long-term capital gains......................................     15,000
                                                   ------------         
    Gross income.............................................     89,950
Deductions:                                                             
  Rental expenses.................................     $5,000           
  Trustee's commissions...........................      2,925           
  Capital gain deduction..........................      7,500           
  Distributions to beneficiaries..................     67,025           
  Personal exemption..............................        300           
                                                     --------     82,750
                                                              ----------
    Taxable income................................                 7,200
                                                                        

The trust is not allowed a deduction for the portion ($975) of the 
trustee's commissions allocable to tax-exempt interest in computing its 
taxable income.
    (f) In determining the character of the amounts includible in the 
gross income of A and B, it is assumed that the trustee elects to 
allocate to rents the expenses not directly attributable to a specific 
item of income other than the portion ($975) of such expenses allocated 
to tax-exempt interest. The

[[Page 78]]

allocation of expenses among the items of income is shown below:

----------------------------------------------------------------------------------------------------------------
                                                                                      Tax-exempt                
                                                           Rents       Dividends       interest         Total   
----------------------------------------------------------------------------------------------------------------
Income for trust accounting purposes.................    $25,000       $50,000         $25,000       $100,000   
Less:                                                                                                           
  Rental expenses....................................      5,000     ............  ...............      5,000   
  Trustee's commissions..............................      2,925     ............          975          3,900   
                                                      ==========================================================
    Total deductions.................................      7,925             0             975          8,900   
                                                      ----------------------------------------------------------
Character of amounts in the hands of the                                                                        
 beneficiaries.......................................     17,075        50,000          24,025      \1\91,100   
----------------------------------------------------------------------------------------------------------------
\1\Distributable net income.                                                                                    

Inasmuch as the income of the trust is to be distributed equally to A 
and B, each is deemed to have received one-half of each item of income; 
that is, rents of $8,537.50, dividends of $25,000, and tax-exempt 
interest of $12,012.50. The dividends of $25,000 allocated to each 
beneficiary are to be aggregated with his other dividends (if any) for 
purposes of the dividend exclusion provided by section 116 and the 
dividend received credit allowed under section 34. Also, each 
beneficiary is allowed a deduction of $2,500 for depreciation of rental 
property attributable to the portion (one-half) of the income of the 
trust distributed to him.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6712, 29 FR 
3655, Mar. 24, 1964]

   estates and trusts which may accumulate income or which distribute 
                                 corpus



Sec. 1.661(a)-1   Estates and trusts accumulating income or distributing corpus; general.

    Subpart C, part I, subchapter J, chapter 1 of the Code, is 
applicable to all decedents' estates and their beneficiaries, and to 
trusts and their beneficiaries other than trusts subject to the 
provisions of subpart B of such part I (relating to trusts which 
distribute current income only, or ``simple'' trusts). A trust which is 
required to distribute amounts other than income during the taxable year 
may be subject to subpart B, and not subpart C, in the absence of an 
actual distribution of amounts other than income during the taxable 
year. See Secs. 1.651(a)-1 and 1.651(a)-3. A trust to which subpart C is 
applicable is referred to as a ``complex'' trust in this part. Section 
661 has no application to amounts excluded under section 663(a).



Sec. 1.661(a)-2   Deduction for distributions to beneficiaries.

    (a) In computing the taxable income of an estate or trust there is 
allowed under section 661(a) as a deduction for distributions to 
beneficiaries the sum of:
    (1) The amount of income for the taxable year which is required to 
be distributed currently, and
    (2) Any other amounts properly paid or credited or required to be 
distributed for such taxable year.

However, the total amount deductible under section 661(a) cannot exceed 
the distributable net income as computed under section 643(a) and as 
modified by section 661(c). See Sec. 1.661(c)-1.
    (b) The term income required to be distributed currently includes 
any amount required to be distributed which may be paid out of income or 
corpus (such as an annuity), to the extent it is paid out of income for 
the taxable year. See Sec. 1.651(a)-2 which sets forth additional rules 
which are applicable in determining whether income of an estate or trust 
is required to be distributed currently.
    (c) The term any other amounts properly paid, credited, or required 
to be distributed includes all amounts properly paid, credited, or 
required to be distributed by an estate or trust during the taxable year 
other than income required to be distributed currently. Thus, the term 
includes the payment of an annuity to the extent it is not paid out of 
income for the taxable year, and

[[Page 79]]

a distribution of property in kind (see paragraph (f) of this section). 
However, see section 663(a) and regulations thereunder for distributions 
which are not included. Where the income of an estate or trust may be 
accumulated or distributed in the discretion of the fiduciary, or where 
the fiduciary has a power to distribute corpus to a beneficiary, any 
such discretionary distribution would qualify under section 661(a)(2). 
The term also includes an amount applied or distributed for the support 
of a dependent of a grantor or of a trustee or cotrustee under the 
circumstances described in section 677(b) or section 678(c) out of 
corpus or out of other than income for the taxable year.
    (d) The terms income required to be distributed currently and any 
other amounts properly paid or credited or required to be distributed 
also include any amount used to discharge or satisfy any person's legal 
obligation as that term is used in Sec. 1.662(a)-4.
    (e) The terms income required to be distributed currently and any 
other amounts properly paid or credited or required to be distributed 
include amounts paid, or required to be paid, during the taxable year 
pursuant to a court order or decree or under local law, by a decedent's 
estate as an allowance or award for the support of the decedent's widow 
or other dependent for a limited period during the administration of the 
estate. The term any other amounts properly paid or credited or required 
to be distributed does not include the value of any interest in real 
estate owned by a decedent, title to which under local law passes 
directly from the decedent to his heirs or devisees.
    (f) If property is paid, credited, or required to be distributed in 
kind:
    (1) No gain or loss is realized by the trust or estate (or the other 
beneficiaries) by reason of the distribution, unless the distribution is 
in satisfaction of a right to receive a distribution in a specific 
dollar amount or in specific property other than that distributed.
    (2) In determining the amount deductible by the trust or estate and 
includible in the gross income of the beneficiary the property 
distributed in kind is taken into account at its fair market value at 
the time it was distributed, credited, or required to be distributed.
    (3) The basis of the property in the hands of the beneficiary is its 
fair market value at the time it was paid, credited, or required to be 
distributed, to the extent such value is included in the gross income of 
the beneficiary. To the extent that the value of property distributed in 
kind is not included in the gross income of the beneficiary, its basis 
in the hands of the beneficiary is governed by the rules in sections 
1014 and 1015 and the regulations thereunder. For this purpose, if the 
total value of cash and property distributed, credited, or required to 
be distributed in kind to a beneficiary in any taxable year exceeds the 
amount includible in his gross income for that year, the value of the 
property other than cash is normally considered as includible in his 
gross income only to the extent that the amount includible exceeds the 
cash paid, credited, or required to be distributed to the beneficiary in 
that year. Further, to the extent that the value of different items of 
property other than cash is includible in the gross income of a 
beneficiary in accordance with the preceding sentence, a pro rata 
portion of the total value of each item of property distributed, 
credited, or required to be distributed is normally considered as 
includible in the beneficiary's gross income.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7287, 38 FR 26912, Sept. 27, 1973]



Sec. 1.661(b)-1   Character of amounts distributed; in general.

    In the absence of specific provisions in the governing instrument 
for the allocation of different classes of income, or unless local law 
requires such an allocation, the amount deductible for distributions to 
beneficiaries under section 661(a) is treated as consisting of the same 
proportion of each class of items entering into the computation of 
distributable net income as the total of each class bears to the total 
distributable net income. For example, if a trust has distributable net 
income of $20,000, consisting of $10,000 each of taxable interest and 
royalties and distributes $10,000 to beneficiary A, the deduction of 
$10,000 allowable under section

[[Page 80]]

661(a) is deemed to consist of $5,000 each of taxable interest and 
royalties, unless the trust instrument specifically provides for the 
distribution or accumulation of different classes of income or unless 
local law requires such an allocation. See also Sec. 1.661(c)-1.



Sec. 1.661(b)-2   Character of amounts distributed when charitable contributions are made.

    In the application of the rule stated in Sec. 1.661(b)-1, the items 
of deduction which enter into the computation of distributable net 
income are allocated among the items of income which enter into the 
computation of distributable net income in accordance with the rules set 
forth in Sec. 1.652(b)-3, except that, in the absence of specific 
provisions in the governing instrument, or unless local law requires a 
different apportionment, amounts paid, permanently set aside, or to be 
used for the charitable, etc., purposes specified in section 642(c) are 
first ratably apportioned among each class of items of income entering 
into the computation of the distributable net income of the estate or 
trust, in accordance with the rules set out in paragraph (b) of 
Sec. 1.643(a)-5.



Sec. 1.661(c)-1   Limitation on deduction.

    An estate or trust is not allowed a deduction under section 661(a) 
for any amount which is treated under section 661(b) as consisting of 
any item of distributable net income which is not included in the gross 
income of the estate or trust. For example, if in 1962, a trust, which 
reports on the calendar year basis, has distributable net income of 
$20,000, which is deemed to consist of $10,000 of dividends and $10,000 
of tax-exempt interest, and distributes $10,000 to beneficiary A, the 
deduction allowable under section 661(a) (computed without regard to 
section 661(c)) would amount to $10,000 consisting of $5,000 of 
dividends and $5,000 of tax-exempt interest. The deduction actually 
allowable under section 661(a) as limited by section 661(c) is $4,975, 
since no deduction is allowable for the $5,000 of tax-exempt interest 
and the $25 deemed distributed out of the $50 of dividends excluded 
under section 116, items of distributable net income which are not 
included in the gross income of the estate or trust.

[T.D. 6777, 29 FR 17809, Dec. 16, 1964]



Sec. 1.661(c)-2  Illustration of the provisions of section 661.

    The provisions of section 661 may be illustrated by the following 
example:

    Example. (a) Under the terms of a trust, which reports on the 
calendar year basis, $10,000 a year is required to be paid out of income 
to a designated charity. The balance of the income may, in the trustee's 
discretion, be accumulated or distributed to beneficiary A. Expenses are 
allocable against income and the trust instrument requires a reserve for 
depreciation. During the taxable year 1955 the trustee contributes 
$10,000 to charity and in his discretion distributes $15,000 of income 
to A. The trust has the following items of income and expense for the 
taxable year 1955:

Dividends........................................................$10,000
Partially tax-exempt interest.....................................10,000
Fully tax-exempt interest.........................................10,000
Rents.............................................................20,000
Rental expenses....................................................2,000
Depreciation of rental property....................................3,000
Trustee's commissions..............................................5,000

    (b) The income of the trust for fiduciary accounting purposes is 
$40,000, computed as follows:

Dividends....................................................    $10,000
Partially tax-exempt interest................................     10,000
Fully tax-exempt interest....................................     10,000
Rents........................................................     20,000
                                                   ------------         
    Total....................................................     50,000
Less:                                                                   
  Rental expenses.................................     $2,000           
  Depreciation....................................      3,000           
  Trustee's commissions...........................      5,000           
                                                   ------------         
                                                                  10,000
                                                   ------------         
    Income as computed under section 643(b)..................     40,000
                                                                        

    (c) The distributable net income of the trust as computed under 
section 643(a) is $30,000, determined as follows:

Rents............................                                $20,000
Dividends........................                                 10,000
Partially tax-exempt interest....                                 10,000
Fully tax-exempt interest........                   $10,000             
Less:                                                                   
  Expenses allocable thereto                                            
   (10,000/50,000 x $5,000)......       $1,000                          

[[Page 81]]

                                                                        
  Charitable contributions                                              
   allocable thereto (10,000/                                           
   50,000 x $10,000).............        2,000                          
                                  --------------                        
                                                      3,000             
                                               --------------           
                                                                   7,000
                                                            ------------
    Total........................                                 47,000
Deductions:                                                             
  Rental expenses................                     2,000             
  Depreciation of rental property                     3,000             
  Trustee's commissions ($5,000                                         
   less $1,000 allocated to tax-                                        
   exempt interest)..............                     4,000             
  Charitable contributions                                              
   ($10,000 less $2,000 allocated                                       
   to tax-exempt interest).......                     8,000             
                                               --------------           
                                                                  17,000
                                                            ------------
    Distributable net income                                            
     (section 643(a))............                                 30,000
                                                                        

    (d) The character of the amounts distributed under section 661(a), 
determined in accordance with the rules prescribed in Secs. 1.661(b)-1 
and 1.661(b)-2 is shown by the following table (for the purpose of this 
allocation, it is assumed that the trustee elected to allocate the 
trustee's commissions to rental income except for the amount required to 
be allocated to tax-exempt interest):

----------------------------------------------------------------------------------------------------------------
                                                                       Partially tax-                           
                                   Rental      Taxable      Excluded       exempt       Tax-exempt      Total   
                                   income     dividends    dividends      interest       interest               
----------------------------------------------------------------------------------------------------------------
Trust income..................    $20,000       $9,950        $50         $10,000        $10,000       $50,000  
Less:                                                                                                           
  Charitable contributions....      4,000        2,000    ...........       2,000          2,000        10,000  
  Rental expenses.............      2,000    ...........  ...........  .............  .............      2,000  
  Depreciation................      3,000    ...........  ...........  .............  .............      3,000  
  Trustee's commissions.......      4,000    ...........  ...........  .............       1,000         5,000  
                               ---------------------------------------------------------------------------------
    Total deductions..........     13,000        2,000          0           2,000          3,000        20,000  
Distributable net income......      7,000        7,950         50           8,000          7,000        30,000  
Amounts deemed distributed                                                                                      
 under section 661(a) before                                                                                    
 applying the limitation of                                                                                     
 section 661(c)...............      3,500        3,975         25           4,000          3,500        15,000  
----------------------------------------------------------------------------------------------------------------

In the absence of specific provisions in the trust instrument for the 
allocation of different classes of income, the charitable contribution 
is deemed to consist of a pro rata portion of the gross amount of each 
items of income of the trust (except dividends excluded under section 
116) and the trust is deemed to have distributed to A a pro rata portion 
(one-half) of each item of income included in distributable net income.
    (e) The taxable income of the trust is $11,375 computed as follows:

Rental income................................................    $20,000
Dividends ($10,000 less $50 exclusion).......................      9,950
Partially tax-exempt interest................................     10,000
                                                   ------------         
    Gross income.............................................     39,950
Deductions:                                                             
  Rental expenses.................................     $2,000           
  Depreciation of rental property.................      3,000           
  Trustee's commissions...........................      4,000           
  Charitable contributions........................      8,000           
  Distributions to A..............................     11,475           
  Personal exemption..............................        100           
                                                   ------------         
                                                                  28,575
                                                              ----------
    Taxable income...........................................     11,375
                                                                        


[[Page 82]]

In computing the taxable income of the trust no deduction is allowable 
for the portions of the charitable contributions deduction ($2,000) and 
trustee's commissions ($1,000) which are treated under section 661(b) as 
attributable to the tax-exempt interest excludable from gross income. 
Also, of the dividends of $4,000 deemed to have been distributed to A 
under section 661(a), $25 ( 25/50ths of $50) is deemed to have been 
distributed from the excluded dividends and is not an allowable 
deduction to the trust. Accordingly, the deduction allowable under 
section 661 is deemed to be composed of $3,500 rental income, $3,975 of 
dividends, and $4,000 partially tax-exempt interest. No deduction is 
allowable for the portion of tax-exempt interest or for the portion of 
the excluded dividends deemed to have been distributed to the 
beneficiary.
    (f) The trust is entitled to the credit allowed by section 34 with 
respect to dividends of $5,975 ($9,950 less $3,975 distributed to A) 
included in gross income. Also, the trust is allowed the credit provided 
by section 35 with respect to partially tax-exempt interest of $6,000 
($10,000 less $4,000 deemed distributed to A) included in gross income.
    (g) Dividends of $4,000 allocable to A are to be aggregated with his 
other dividends (if any) for purposes of the dividend exclusion under 
section 116 and the dividend received credit under section 84.



Sec. 1.662(a)-1  Inclusion of amounts in gross income of beneficiaries of estates and complex trusts; general.

    There is included in the gross income of a beneficiary of an estate 
or complex trust the sum of:
    (a) Amounts of income required to be distributed currently to him, 
and
    (b) All other amounts properly paid, credited, or required to be 
distributed to him

by the estate or trust. The preceding sentence is subject to the rules 
contained in Sec. 1.662(a)-2 (relating to currently distributable 
income), Sec. 1.662(a)-3 (relating to other amounts distributed), and 
Secs. 1.662(b)-1 and 1.662(b)-2 (relating to character of amounts). 
Section 662 has no application to amounts excluded under section 663(a).



Sec. 1.662(a)-2   Currently distributable income.

    (a) There is first included in the gross income of each beneficiary 
under section 662(a)(1) the amount of income for the taxable year of the 
estate or trust required to be distributed currently to him, subject to 
the provisions of paragraph (b) of this section. Such amount is included 
in the beneficiary's gross income whether or not it is actually 
distributed.
    (b) If the amount of income required to be distributed currently to 
all beneficiaries exceeds the distributable net income (as defined in 
section 643(a) but computed without taking into account the payment, 
crediting, or setting aside of an amount for which a charitable 
contributions deduction is allowable under section 642(c)) of the estate 
or trust, then there is included in the gross income of each beneficiary 
an amount which bears the same ratio to distributable net income (as so 
computed) as the amount of income required to be distributed currently 
to the beneficiary bears to the amount required to be distributed 
currently to all beneficiaries.
    (c) The phrase the amount of income for the taxable year required to 
be distributed currently includes any amount required to be paid out of 
income or corpus to the extent the amount is satisfied out of income for 
the taxable year. Thus, an annuity required to be paid in all events 
(either out of income or corpus) would qualify as income required to be 
distributed currently to the extent there is income (as defined in 
section 643(b)) not paid, credited, or required to be distributed to 
other beneficiaries for the taxable year. If an annuity or a portion of 
an annuity is deemed under this paragraph to be income required to be 
distributed currently, it is treated in all respects in the same manner 
as an amount of income actually required to be distributed currently. 
The phrase the amount of income for the taxable year required to be 
distributed currently also includes any amount required to be paid 
during the taxable year in all events (either out of income or corpus) 
pursuant to a court order or decree or under local law, by a decedent's 
estate as an allowance or award for the support of the decedent's widow 
or other dependent for a limited period during the administration of the 
estate to the extent there is income (as defined in section 643(b)) of 
the estate for the taxable year not paid, credited, or required to be 
distributed to other beneficiaries.

[[Page 83]]

    (d) If an annuity is paid, credited, or required to be distributed 
tax free, that is, under a provision whereby the executor or trustee 
will pay the income tax of the annuitant resulting from the receipt of 
the annuity, the payment of or for the tax by the executor or trustee 
will be treated as income paid, credited, or required to be distributed 
currently to the extent it is made out of income.
    (e) The application of the rules stated in this section may be 
illustrated by the following examples:

    Example 1. (1) Assume that under the terms of the trust instrument 
$5,000 is to be paid to X charity out of income each year; that $20,000 
of income is currently distributable to A; and that an annuity of 
$12,000 is to be paid to B out of income or corpus. All expenses are 
charges against income and capital gains are allocable to corpus. During 
the taxable year the trust had income of $30,000 (after the payment of 
expenses) derived from taxable interest and made the payments to X 
charity and distributions to A and B as required by the governing 
instrument.
    (2) The amounts treated as distributed currently under section 
662(a)(1) total $25,000 ($20,000 to A and $5,000 to B). Since the 
charitable contribution is out of income the amount of income available 
for B's annuity is only $5,000. The distributable net income of the 
trust computed under section 643(a) without taking into consideration 
the charitable contributions deduction of $5,000 as provided by section 
661(a)(1), is $30,000. Since the amounts treated as distributed 
currently of $25,000 do not exceed the distributable net income (as 
modified) of $30,000, A is required to include $20,000 in his gross 
income and B is required to include $5,000 in his gross income under 
section 662(a)(1).
    Example 2. Assume the same facts as in paragraph (1) of example 1, 
except that the trust has, in addition, $10,000 of administration 
expenses, commissions, etc., chargeable to corpus. The amounts treated 
as distributed currently under section 662(a)(1) total $25,000 ($20,000 
to A and $5,000 to B), since trust income under section 643(b) remains 
the same as in example 1. Distributable net income of the trust computed 
under section 643(a) but without taking into account the charitable 
contributions deduction of $5,000 as provided by section 662(a)(1) is 
only $20,000. Since the amounts treated as distributed currently of 
$25,000 exceed the distributable net income (as so computed) of $20,000, 
A is required to include $16,000 (20,000/25,000 of $20,000) in his gross 
income and B is required to include $4,000 (5,000/25,000 of $20,000) in 
his gross income under section 662(a)(1). Because A and B are 
beneficiaries of amounts of income required to be distributed currently, 
they do not benefit from the reduction of distributable net income by 
the charitable contributions deduction.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7287, 38 FR 26912, Sept. 27, 1973]



Sec. 1.662(a)-3  Other amounts distributed.

    (a) There is included in the gross income of a beneficiary under 
section 662(a)(2) any amount properly paid, credited, or required to be 
distributed to the beneficiary for the taxable year, other than (1) 
income required to be distributed currently, as determined under 
Sec. 1.662(a)-2, (2) amounts excluded under section 663(a) and the 
regulations thereunder, and (3) amounts in excess of distributable net 
income (see paragraph (c) of this section). An amount which is credited 
or required to be distributed is included in the gross income of a 
beneficiary whether or not it is actually distributed.
    (b) Some of the payments to be included under paragraph (a) of this 
section are: (1) A distribution made to a beneficiary in the discretion 
of the fiduciary; (2) a distribution required by the terms of the 
governing instrument upon the happening of a specified event; (3) an 
annuity which is required to be paid in all events but which is payable 
only out of corpus; (4) a distribution of property in kind (see 
paragraph (f) of Sec. 1.661(a)-2); (5) an amount applied or distributed 
for the support of a dependent of a grantor or a trustee or cotrustee 
under the circumstances specified in section 677(b) or section 678(c) 
out of corpus or out of other than income for the taxable year; and (6) 
an amount required to be paid during the taxable year pursuant to a 
court order or decree or under local law, by a decedent's estate as an 
allowance or award for the support of the decedent's widow or other 
dependent for a limited period during the administration of the estate 
which is payable only out of corpus of the estate under the order or 
decree or local law.
    (c) If the sum of the amounts of income required to be distributed 
currently (as determined under Sec. 1.662(a)-2) and other amounts 
properly paid, credited, or required to be distributed (as determined 
under paragraph (a) of this

[[Page 84]]

section) exceeds distributable net income (as defined in section 
643(a)), then such other amounts properly paid, credited, or required to 
be distributed are included in gross income of the beneficiary but only 
to the extent of the excess of such distributable net income over the 
amounts of income required to be distributed currently. If the other 
amounts are paid, credited, or required to be distributed to more than 
one beneficiary, each beneficiary includes in gross income his 
proportionate share of the amount includible in gross income pursuant to 
the preceding sentence. The proportionate share is an amount which bears 
the same ratio to distributable net income (reduced by amounts of income 
required to be distributed currently) as the other amounts (as 
determined under paragraphs (a) and (d) of this section) distributed to 
the beneficiary bear to the other amounts distributed to all 
beneficiaries. For treatment of excess distributions by trusts, see 
sections 665 to 668, inclusive, and the regulations thereunder.
    (d) The application of the rules stated in this section may be 
illustrated by the following example:

    Example. The terms of a trust require the distribution annually of 
$10,000 of income to A. If any income remains, it may be accumulated or 
distributed to B, C, and D in amounts in the trustee's discretion. He 
may also invade corpus for the benefit of A, B, C, or D. In the taxable 
year, the trust has $20,000 of income after the deduction of all 
expenses. Distributable net income is $20,000. The trustee distributes 
$10,000 of income to A. Of the remaining $10,000 of income, he 
distributes $3,000 each to B, C, and D, and also distributes an 
additional $5,000 to A. A includes $10,000 in income under section 
662(a)(1). The ``other amounts distributed'' amount of $14,000, 
includible in the income of the recipients to the extent of $10,000, 
distributable net income less the income currently distributable to A. A 
will include an additional $3,571 (5,000/14,000 x $10,000) in income 
under this section, and B, C, and D will each include $2,143 (3,000/
14,000 x $10,000).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7287, 38 FR 26913, Sept. 27, 1973]



Sec. 1.662(a)-4  Amounts used in discharge of a legal obligation.

    Any amount which, pursuant to the terms of a will or trust 
instrument, is used in full or partial discharge or satisfaction of a 
legal obligation of any person is included in the gross income of such 
person under section 662(a) (1) or (2), whichever is applicable, as 
though directly distributed to him as a beneficiary, except in cases to 
which section 71 (relating to alimony payments) or section 682 (relating 
to income of a trust in case of divorce, etc.) applies. The term legal 
obligation includes a legal obligation to support another person if, and 
only if, the obligation is not affected by the adequacy of the 
dependent's own resources. For example, a parent has a ``legal 
obligation'' within the meaning of the preceding sentence to support his 
minor child if under local law property or income from property owned by 
the child cannot be used for his support so long as his parent is able 
to support him. On the other hand, if under local law a mother may use 
the resources of a child for the child's support in lieu of supporting 
him herself, no obligation of support exists within the meaning of this 
paragraph, whether or not income is actually used for support. 
Similarly, since under local law a child ordinarily is obligated to 
support his parent only if the parent's earnings and resources are 
insufficient for the purpose, no obligation exists whether or not the 
parent's earnings and resources are sufficient. In any event the amount 
of trust income which is included in the gross income of a person 
obligated to support a dependent is limited by the extent of his legal 
obligation under local law. In the case of a parent's obligation to 
support his child, to the extent that the parent's legal obligation of 
support, including education, is determined under local law by the 
family's station in life and by the means of the parent, it is to be 
determined without consideration of the trust income in question.



Sec. 1.662(b)-1  Character of amounts; when no charitable contributions are made.

    In determining the amount includible in the gross income of a 
beneficiary, the amounts which are determined under section 662(a) and 
Secs. 1.662(a)-1 through 1.662(a)-4 shall have the same character in the 
hands of the beneficiary as in the hands of the estate or

[[Page 85]]

trust. The amounts are treated as consisting of the same proportion of 
each class of items entering into the computation of distributable net 
income as the total of each class bears to the total distributable net 
income of the estate or trust unless the terms of the governing 
instrument specifically allocate different classes of income to 
different beneficiaries, or unless local law requires such an 
allocation. For this purpose, the principles contained in Sec. 1.652(b)-
1 shall apply.



Sec. 1.662(b)-2  Character of amounts; when charitable contributions are made.

    When a charitable contribution is made, the principles contained in 
Secs. 1.652(b)-1 and 1.662(b)-1 generally apply. However, before the 
allocation of other deductions among the items of distributable net 
income, the charitable contributions deduction allowed under section 
642(c) is (in the absence of specific allocation under the terms of the 
governing instrument or the requirement under local law of a different 
allocation) allocated among the classes of income entering into the 
computation of estate or trust income in accordance with the rules set 
forth in paragraph (b) of Sec. 1.643(a)-5. In the application of the 
preceding sentence, for the purpose of allocating items of income and 
deductions to beneficiaries to whom income is required to be distributed 
currently, the amount of the charitable contributions deduction is 
disregarded to the extent that it exceeds the income of the trust for 
the taxable year reduced by amounts for the taxable year required to be 
distributed currently. The application of this section may be 
illustrated by the following examples (of which example (1) is 
illustrative of the preceding sentence):

    Example 1. (a) A trust instrument provides that $30,000 of its 
income must be distributed currently to A, and the balance may either be 
distributed to B, distributed to a designated charity, or accumulated. 
Accumulated income may be distributed to B and to the charity. The trust 
for its taxable year has $40,000 of taxable interest and $10,000 of tax-
exempt income, with no expenses. The trustee distributed $30,000 to A, 
$50,000 to charity X, and $10,000 to B.
    (b) Distributable net income for the purpose of determining the 
character of the distribution to A is $30,000 (the charitable 
contributions deduction, for this purpose, being taken into account only 
to the extent of $20,000, the difference between the income of the trust 
for the taxable year, $50,000, and the amount required to be distributed 
currently, $30,000).
    (c) The charitable contributions deduction taken into account, 
$20,000, is allocated proportionately to the items of income of the 
trust, $16,000 to taxable interest and $4,000 to tax-exempt income.
    (d) Under section 662(a)(1), the amount of income required to be 
distributed currently to A is $30,000, which consists of the balance of 
these items, $24,000 of taxable interest and $6,000 of tax-exempt 
income.
    (e) In determining the amount to be included in the gross income of 
B under section 662 for the taxable year, however, the entire charitable 
contributions deduction is taken into account, with the result that 
there is no distributable net income and therefore no amount to be 
included in gross income.
    (f) See subpart D (section 665 and following), part I, subchapter J, 
chapter 1 of the Code for application of the throwback provisions to the 
distribution made to B.
    Example 2. The net income of a trust is payable to A for life, with 
the remainder to a charitable organization. Under the terms of the trust 
instrument and local law capital gains are added to corpus. During the 
taxable year the trust receives dividends of $10,000 and realized a 
long-term capital gain of $10,000, for which a long-term capital gain 
deduction of $5,000 is allowed under section 1202. Since under the trust 
instrument and local law the capital gains are allocated to the 
charitable organization, and since the capital gain deduction is 
directly attributable to the capital gain, the charitable contributions 
deduction and the capital gain deduction are both allocable to the 
capital gain, and dividends in the amount of $10,000 are allocable to A.



Sec. 1.662(c)-1   Different taxable years.

    If a beneficiary has a different taxable year (as defined in section 
441 or 442) from the taxable year of an estate or trust, the amount he 
is required to include in gross income in accordance with section 662 
(a) and (b) is based upon the distributable net income of the estate or 
trust and the amounts properly paid, credited, or required to be 
distributed to the beneficiary for any taxable year or years of the 
estate or trust ending with or within his taxable year. This rule 
applies as to so-called short taxable years as well as

[[Page 86]]

taxable years of normal duration. Income of an estate or trust for its 
taxable year or years is determined in accordance with its method of 
accounting and without regard to that of the beneficiary.



Sec. 1.662(c)-2   Death of individual beneficiary.

    If an amount specified in section 662(a) (1) or (2) is paid, 
credited, or required to be distributed by an estate or trust for a 
taxable year which does not end with or within the last taxable year of 
a beneficiary (because of the beneficiary's death), the extent to which 
the amount is included in the gross income of the beneficiary for his 
last taxable year or in the gross income of his estate is determined by 
the computations under section 662 for the taxable year of the estate or 
trust in which his last taxable year ends. Thus, the distributable net 
income and the amounts paid, credited, or required to be distributed for 
the taxable year of the estate or trust, determine the extent to which 
the amounts paid, credited, or required to be distributed to the 
beneficiary are included in his gross income for his last taxable year 
or in the gross income of his estate. (Section 662(c) does not apply to 
such amounts.) The gross income for the last taxable year of a 
beneficiary on the cash basis includes only income actually distributed 
to the beneficiary before his death. Income required to be distributed, 
but in fact distributed to his estate, is included in the gross income 
of the estate as income in respect of a decedent under section 691. See 
paragraph (e) of Sec. 1.663(c)-3 with respect to separate share 
treatment for the periods before and after the death of a trust's 
beneficiary.



Sec. 1.662(c)-3   Termination of existence of other beneficiaries.

    If the existence of a beneficiary which is not an individual 
terminates, the amount to be included under section 662(a) in its gross 
income for the last taxable year is computed with reference to 
Secs. 1.662(c)-1 and 1.662(c)-2 as if the beneficiary were a deceased 
individual, except that income required to be distributed prior to the 
termination but actually distributed to the beneficiary's successor in 
interest is included in the beneficiary's income for its last taxable 
year.



Sec. 1.662(c)-4   Illustration of the provisions of sections 661 and 662.

    The provisions of sections 661 and 662 may be illustrated in general 
by the following example:

    Example. (a) Under the terms of a testamentary trust one-half of the 
trust income is to be distributed currently to W, the decedent's wife, 
for her life. The remaining trust income may, in the trustee's 
discretion, either be paid to D, the grantor's daughter, paid to 
designated charities, or accumulated. The trust is to terminate at the 
death of W and the principal will then be payable to D. No provision is 
made in the trust instrument with respect to depreciation of rental 
property. Capital gains are allocable to the principal account under the 
applicable local law. The trust and both beneficiaries file returns on 
the calendar year basis. The records of the fiduciary show the following 
items of income and deduction for the taxable year 1955:

Rents........................................................    $50,000
Dividends of domestic corporations...........................     50,000
Tax-exempt interest..........................................     20,000
Partially tax-exempt interest................................     10,000
Capital gains (long term)....................................     20,000
Depreciation of rental property..............................     10,000
Expenses attributable to rental income.......................     15,400
Trustee's commissions allocable to income account............      2,800
Trustee's commissions allocable to principal account.........      1,100
                                                                        

    (b) The income for trust accounting purposes is $111,800, and the 
trustee distributes one-half ($55,900) to W and in his discretion makes 
a contribution of one-quarter ($27,950) to charity X and distributes the 
remaining one-quarter ($27,950) to D. The total of the distributions to 
beneficiaries is $83,850, consisting of (1) income required to be 
distributed currently to W of $55,900 and (2) other amounts properly 
paid or credited to D of $27,950. The income for trust accounting 
purposes of $111,800 is determined as follows:

Rents........................................................    $50,000
Dividends....................................................     50,000
Tax-exempt interest..........................................     20,000
Partially tax-exempt interest................................     10,000
                                                   ------------         
    Total....................................................    130,000
Less:                                                                   
  Rental expenses.................................    $15,400           
  Trustee's commissions allocable to income                             
   account........................................      2,800           
                                                     --------     18,200
                                                              ----------
    Income as computed under section 643(b).......    111,800           
                                                                        


[[Page 87]]

    (c) The distributable net income of the trust as computed under 
section 643(a) is $82,750, determined as follows:

                                                                                                                
                                                                                                                
                                                                                                                
Rents..........  ..........................................................  ...........      $50,000           
Dividends......  ..........................................................  ...........       50,000           
Partially tax-                                                                                                  
 exempt                                                                                                         
 interest......  ..........................................................  ...........       10,000           
Tax-exempt                                                                                                      
 interest......  ..........................................................      $20,000                        
Less:                                                                                                           
  Trustee's                                                                                                     
   commissions                                                                                                  
   allocable                                                                                                    
   thereto                                                                                                      
   (20,000/                                                                                                     
   130,000 of                                                                                                   
   $3,900).....  $600......................................................                                     
  Charitable                                                                                                    
   contribution                                                                                                 
   s allocable                                                                                                  
   thereto                                                                                                      
   (20,000/                                                                                                     
   130,000 of                                                                                                   
   $27,950)....  4,300.....................................................                                     
                -------------------------------------------------------------                                   
                 ----------................................................        4,900                        
                                                                              ----------       15,100           
                                                                                         --------------         
    Total......  ..........................................................  ...........      125,100           
Deductions:                                                                                                     
  Rental                                                                                                        
   expenses....  ..........................................................       15,400                        
  Trustee's                                                                                                     
   commissions                                                                                                  
   ($3,900 less                                                                                                 
   $600                                                                                                         
   allocated to                                                                                                 
   tax-exempt                                                                                                   
   interest)...  ..........................................................        3,300                        
  Charitable                                                                                                    
   deduction                                                                                                    
   ($27,950                                                                                                     
   less $4,300                                                                                                  
   attributable                                                                                                 
   to tax-                                                                                                      
   exempt                                                                                                       
   interest)...  ..........................................................       23,650                        
                                                                              ----------       42,350           
                                                                                         --------------         
    Distributab                                                                                                 
     le net                                                                                                     
     income....  ..........................................................  ...........       82,750           
----------------------------------------------------------------------------------------------------------------

In computing the distributable net income of $82,750, the taxable income 
of the trust was computed with the following modifications: No 
deductions were allowed for distributions to beneficiaries and for 
personal exemption of the trust (section 643(a) (1) and (2)); capital 
gains were excluded and no deduction under section 1202 (relating to the 
50 percent deduction for long-term capital gains) was taken into account 
(section 643(a)(3)); and the tax-exempt interest (as adjusted for 
expenses and charitable contributions) and the dividend exclusion of $50 
were included (section 643(a) (5) and (7)).
    (d) Inasmuch as the distributable net income of $82,750 as 
determined under section 643(a) is less than the sum of the amounts 
distributed to W and D of $83,850, the deduction allowable to the trust 
under section 661(a) is such distributable net income as modified under 
section 661(c) to exclude therefrom the items of income not included in 
the gross income of the trust, as follows:

Distributable net income.....................................    $82,750
Less:                                                                   
  Tax-exempt interest (as adjusted for expenses                         
   and the charitable contributions)..............    $15,100           
  Dividend exclusion allowable under section 116..         50           
                                                     --------     15,150
                                                              ----------
    Deduction allowable under section 661(a).................     67,600
                                                                        

    (e) For the purpose of determining the character of the amounts 
deductible under section 642(c) and section 661(a), the trustee elected 
to offset the trustee's commissions (other than the portion required to 
be allocated to tax-exempt interest) against the rental income. The 
following table shows the determination of the character of the amounts 
deemed distributed to beneficiaries and contributed to charity.

----------------------------------------------------------------------------------------------------------------
                                                                                           Partially            
                                             Rents      Taxable    Excluded   Tax exempt  tax exempt     Total  
                                                       dividends   dividends   interest    interest             
----------------------------------------------------------------------------------------------------------------
Trust income............................     $50,000     $49,950         $50     $20,000     $10,000    $130,000
Less:                                                                                                           
  Charitable contribution...............      10,750      10,750  ..........       4,300       2,150      27,950
  Rental expenses.......................      15,400  ..........  ..........  ..........  ..........      15,400
  Trustee's commissions.................       3,300  ..........  ..........         600  ..........       3,900
                                         -----------------------------------------------------------------------
    Total deductions....................      29,450      10,750           0       4,900       2,150      47,250
                                         -----------------------------------------------------------------------
Amounts distributable to beneficiaries..      20,550      39,200          50      15,100       7,850      82,750
----------------------------------------------------------------------------------------------------------------


[[Page 88]]

The character of the charitable contribution is determined by 
multiplying the total charitable contribution ($27,950) by a fraction 
consisting of each item of trust income, respectively, over the total 
trust income, except that no part of the dividends excluded from gross 
income are deemed included in the charitable contribution. For example, 
the charitable contribution is deemed to consist of rents of $10,750 
(50,000/130,000 x  $27,950).
    (f) The taxable income of the trust is $9,900 determined as follows:

Rental income................................................    $50,000
Dividends ($50,000 less $50 exclusion).......................     49,950
Partially tax-exempt interest................................     10,000
Capital gains................................................     20,000
                                                   ------------         
    Gross income.............................................    129,950
Deductions:                                                             
  Rental expenses.................................     15,400           
  Trustee's commissions...........................      3,300           
  Charitable contributions........................     23,650           
  Capital gain deduction..........................     10,000           
  Distributions to beneficiaries..................     67,600           
  Personal exemption..............................        100           
                                                   ------------         
                                                                 120,050
                                                              ----------
    Taxable income...........................................      9,900
                                                                        

    (g) In computing the amount includible in W's gross income under 
section 662(a)(1), the $55,900 distribution to her is deemed to be 
composed of the following proportions of the items of income deemed to 
have been distributed to the beneficiaries by the trust (see paragraph 
(e) of this example):

Rents (20,550/82,750 x $55,900)..............................    $13,882
Dividends (39,250/82,750 x $55,900)..........................     26,515
Partially tax-exempt interest (7,850/ 82,750 x $55,900)......      5,303
Tax-exempt interest (15,100/82,750 x $55,900)................     10,200
                                                   ------------         
    Total....................................................     55,900
                                                                        

Accordingly, W will exclude $10,200 of tax-exempt interest from gross 
income and will receive the credits and exclusion for dividends received 
and for partially tax-exempt interest provided in sections 34, 116, and 
35, respectively, with respect to the dividends and partially tax-exempt 
interest deemed to have been distributed to her, her share of the 
dividends being aggregated with other dividends received by her for 
purposes of the dividend credit and exclusion. In addition, she may 
deduct a share of the depreciation deduction proportionate to the trust 
income allocable to her; that is, one-half of the total depreciation 
deduction, or $5,000.
    (h) Inasmuch as the sum of the amount of income required to be 
distributed currently to W ($55,900) and the other amounts properly 
paid, credited, or required to be distributed to D ($27,950) exceeds the 
distributable net income ($82,750) of the trust as determined under 
section 643(a), D is deemed to have received $26,850 ($82,750 less 
$55,900) for income tax purposes. The character of the amounts deemed 
distributed to her is determined as follows:

Rents (20,550/82,750 x $26,850)..............................     $6,668
Dividends (39,250/82,750 x $26,850)..........................     12,735
Partially tax-exempt interest (7,850/ 82,750 x $26,850)......      2,547
Tax-exempt interest (15,100/82,750 x $26,850)................      4,900
                                                   ------------         
    Total....................................................     26,850
                                                                  

Accordingly, D will exclude $4,900 of tax-exempt interest from gross 
income and will receive the crddits and exclusion for dividends received 
and for partially tax-exempt interest provided in sections 34, 116, and 
35, respectively, with respect to the dividends and partially tax-exempt 
interest deemed to have been distributed to her, her share of the 
dividends being aggregated with other dividends received by her for 
purposes of the dividend credit and exclusion. In addition, she may 
deduct a share of the depreciation deduction proportionate to the trust 
income allocable to her; that is, one-fourth of the total depreciation 
deduction, or $2,500.
    (i) [Reserved]
    (j) The remaining $2,500 of the depreciation deduction is allocated 
to the amount distributed to charity X and is hence non-deductible by 
the trust, W, or D. (See Sec. 1.642(e)-1.)



Sec. 1.663(a)-1   Special rules applicable to sections 661 and 662; exclusions; gifts, bequests, etc.

    (a) In general. A gift or bequest of a specific sum of money or of 
specific property, which is required by the specific terms of the will 
or trust instrument and is properly paid or credited to a beneficiary, 
is not allowed as a deduction to an estate or trust under section 661 
and is not included in the gross income of a beneficiary under section 
662, unless under the terms of the will or trust instrument the gift or 
bequest is to be paid or credited to the recipient in more than three 
installments. Thus, in order for a gift or bequest to be excludable from 
the gross income of the recipient, (1) it must qualify as a gift or 
bequest of a specific sum of money or of specific property (see 
paragraph (b) of this section), and (2) the terms of the governing 
instrument must not provide for its payment in more than three 
installments (see paragraph (c) of this section). The date when the 
estate came into existence or the date when the trust was created is 
immaterial.
    (b) Definition of a gift or bequest of a specific sum of money or of 
specific property. (1) In order to qualify as a gift or

[[Page 89]]

bequest of a specific sum of money or of specific property under section 
663(a), the amount of money or the identity of the specific property 
must be ascertainable under the terms of a testator's will as of the 
date of his death, or under the terms of an inter vivos trust instrument 
as of the date of the inception of the trust. For example, bequests to a 
decedent's son of the decedent's interest in a partnership and to his 
daughter of a sum of money equal to the value of the partnership 
interest are bequests of specific property and of a specific sum of 
money, respectively. On the other hand, a bequest to the decedent's 
spouse of money or property, to be selected by the decedent's executor, 
equal in value to a fraction of the decedent's ``adjusted gross estate'' 
is neither a bequest of a specific sum of money or of specific property. 
The identity of the property and the amount of money specified in the 
preceding sentence are dependent both on the exercise of the executor's 
discretion and on the payment of administration expenses and other 
charges, neither of which are facts existing on the date of the 
decedent's death. It is immaterial that the value of the bequest is 
determinable after the decedent's death before the bequest is satisfied 
(so that gain or loss may be realized by the estate in the transfer of 
property in satisfaction of it).
    (2) The following amounts are not considered as gifts or bequests of 
a sum of money or of specific property within the meaning of this 
paragraph:
    (i) An amount which can be paid or credited only from the income of 
an estate or trust, whether from the income for the year of payment or 
crediting, or from the income accumulated from a prior year;
    (ii) An annuity, or periodic gifts of specific property in lieu of 
or having the effect of an annuity;
    (iii) A residuary estate or the corpus of a trust; or
    (iv) A gift or bequest paid in a lump sum or in not more than three 
installments, if the gift or bequest is required to be paid in more than 
three installments under the terms of the governing instrument.
    (3) The provisions of subparagraphs (1) and (2) of this paragraph 
may be illustrated by the following examples, in which it is assumed 
that the gift or bequest is not required to be made in more than three 
installments (see paragraph (c)):

    Example 1. Under the terms of a will, a legacy of $5,000 was left to 
A, 1,000 shares of X company stock was left to W, and the balance of the 
estate was to be divided equally between W and X. No provision was made 
in the will for the disposition of income of the estate during the 
period of administration. The estate had income of $25,000 during the 
taxable year 1954, which was accumulated and added to corpus for estate 
accounting purposes. During the taxable year, the executor paid the 
legacy of $5,000 in a lump sum to A and transferred the X company stock 
to W. No other distributions to beneficiaries were made during the 
taxable year. The distributions to A and W qualify as exclusions within 
the meaning of section 663(a)(1).
    Example (2). Under the terms of a will, the testator's estate was to 
be divided equally between A and B. No provision was made in the will 
for the disposition of income of the estate during the period of 
administration. The estate had income of $50,000 for the taxable year 
1954. In accordance with an agreement among the beneficiaries that part 
of the assets of the estate would be distributed in kind to the 
beneficiaries, stock in corporation X was distributed to A during 1954. 
The fair market value of the stock was $40,000 on the date of 
distribution. No other distribution was made during the year. The 
distribution does not qualify as an exclusion within the meaning of 
section 663(a)(1), since it is not a specific gift to A required by the 
terms of the will. Accordingly, the fair market value of the property 
($40,000) represents a distribution within the meaning of section 661(a) 
and section 662(a) (see paragraph (c) of Sec. 1.661(a)-2).
    Example (3). Under the terms of a trust instrument, income is to be 
accumulated during the minority of A. Upon A's reaching the age of 21, 
$10,000 is to be distributed to B out of income or corpus. Also at that 
time, $10,000 is to be distributed to C out of the accumulated income 
and the remainder of the accumulations are to be paid to A. A is then to 
receive all the income until he is 25, when the trust is to terminate. 
Only the distribution to B would qualify for exclusion under section 
663(a)(1).

    (4) A gift or bequest of a specific sum of money or of specific 
property is not disqualified under this paragraph solely because its 
payment is subject to a condition. For example, provision for a payment 
by a trust to beneficiary A of

[[Page 90]]

$10,000 when he reaches age 25, and $10,000 when he reaches age 30, with 
payment over to B of any amount not paid to A because of his death, is a 
gift to A of a specific sum of money payable in two installments, within 
the meaning of this paragraph, even though the exact amount payable to A 
cannot be ascertained with certainty under the terms of the trust 
instrument.
    (c) Installment payments. (1) In determining whether a gift or 
bequest of a specific sum of money or of specific property, as defined 
in paragraph (b) of this section, is required to be paid or credited to 
a particular beneficiary in more than three installments:
    (i) Gifts or bequests of articles for personal use (such as personal 
and household effects, automobiles, and the like) are disregarded.
    (ii) Specifically devised real property, the title to which passes 
directly from the decedent to the devisee under local law, is not taken 
into account, since it would not constitute an amount paid, credited, or 
required to be distributed under section 661 (see paragraph (e) of 
Sec. 1.661(a)-2).
    (iii) All gifts and bequests under a decedent's will (which are not 
disregarded pursuant to subdivisions (i) and (ii) of this subparagraph) 
for which no time of payment or crediting is specified, and which are to 
be paid or credited in the ordinary course of administration of the 
decedent's estate, are considered as required to be paid or credited in 
a single installment.
    (iv) All gifts and bequests (which are not disregarded pursuant to 
subdivisions (i) and (ii) of this subparagraph) payable at any one 
specified time under the terms of the governing instrument are taken 
into account as a single installment.

For purposes of determining the number of installments paid or credited 
to a particular beneficiary, a decedent's estate and a testamentary 
trust shall each be treated as a separate entity.
    (2) The application of the rules stated in subparagraph (1) of this 
paragraph may be illustrated by the following examples:

    Example (1). (i) Under the terms of a decedent's will, $10,000 in 
cash, household furniture, a watch, an automobile, 100 shares of X 
company stock, 1,000 bushels of grain, 500 head of cattle, and a farm 
(title to which passed directly to A under local law) are bequeathed or 
devised outright to A. The will also provides for the creation of a 
trust for the benefit of A, under the terms of which there are required 
to be distributed to A, $10,000 in cash and 100 shares of Y company 
stock when he reaches 25 years of age, $25,000 in cash and 200 shares of 
Y company stock when he reaches 30 years of age, and $50,000 in cash and 
300 shares of Y company stock when he reaches 35 years of age.
    (ii) The furniture, watch, automobile, and the farm are excluded in 
determining whether any gift or bequest is required to be paid or 
credited to A in more than three installments. These items qualify for 
the exclusion under section 663(a)(1) regardless of the treatment of the 
other items of property bequeathed to A.
    (iii) The $10,000 in cash, the shares of X company stock, the grain, 
the cattle and the assets required to create the trust, to be paid or 
credited by the estate to A and the trust are considered as required to 
be paid or credited in a single installment to each, regardless of the 
manner of payment or distribution by the executor, since no time of 
payment or crediting is specified in the will. The $10,000 in cash and 
shares of Y company stock required to be distributed by the trust to A 
when he is 25 years old are considered as required to be paid or 
distributed as one installment under the trust. Likewise, the 
distributions to be made by the trust to A when he is 30 and 35 years 
old are each considered as one installment under the trust. Since the 
total number of installments to be made by the estate does not exceed 
three, all of the items of money and property distributed by the estate 
qualify for the exclusion under section 663(a)(1). Similarly, the three 
distributions by the trust qualify.
    Example (2). Assume the same facts as in example (1), except that 
another distribution of a specified sum of money is required to be made 
by the trust to A when he becomes 40 years old. This distribution would 
also qualify as an installment, thus making four installments in all 
under the trust. None of the gifts to A under the trust would qualify 
for the exclusion under section 663(a)(1). The situation as to the 
estate, however, would not be changed.
    Example (3). A trust instrument provides that A and B are each to 
receive $75,000 in installments of $25,000, to be paid in alternate 
years. The trustee distributes $25,000 to A in 1954, 1956, and 1958, and 
to B in 1955, 1957, and 1959. The gifts to A and B qualify for exclusion 
under section 663(a)(1), although a total of six payments is made. The 
gifts of $75,000 to each beneficiary are to be separately treated.

[[Page 91]]



Sec. 1.663(a)-2   Charitable, etc., distributions.

    Any amount paid, permanently set aside, or to be used for the 
charitable, etc., purposes specified in section 642(c) and which is 
allowable as a deduction under that section is not allowed as a 
deduction to an estate or trust under section 661 or treated as an 
amount distributed for purposes of determining the amounts includible in 
gross income of beneficiaries under section 662. Amounts paid, 
permanently set aside, or to be used for charitable, etc., purposes are 
deductible by estates or trusts only as provided in section 642(c). For 
purposes of this section, the deduction provided in section 642(c) is 
computed without regard to the provisions of section 508(d), section 
681, or section 4948(c)(4) (concerning unrelated business income and 
private foundations).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7428, 41 FR 
34627, Aug. 16, 1976]



Sec. 1.663(a)-3  Denial of double deduction.

    No amount deemed to have been distributed to a beneficiary in a 
preceding year under section 651 or 661 is included in amounts falling 
within section 661(a) or 662(a). For example, assume that all of the 
income of a trust is required to be distributed currently to beneficiary 
A and both the trust and A report on the calendar year basis. For 
administrative convenience, the trustee distributes in January and 
February 1956 a portion of the income of the trust required to be 
distributed in 1955. The portion of the income for 1955 which was 
distributed by the trust in 1956 may not be claimed as a deduction by 
the trust for 1956 since it is deductible by the trust and includible in 
A's gross income for the taxable year 1955.



Sec. 1.663(b)-1   Distributions in first 65 days of taxable year; scope.

    (a) Taxable years beginning after December 31, 1968--(1) General 
rule. With respect to taxable years beginning after December 31, 1968, 
the fiduciary of a trust may elect under section (b) to 663 treat any 
amount or portion thereof that is properly paid or credited to a 
beneficiary within the first 65 days following the close of the taxable 
year as an amount that was properly paid or credited on the last day of 
such taxable year.
    (2) Effect of election. (i) An election is effective only with 
respect to the taxable year for which the election is made. In the case 
of distributions made after May 8, 1972, the amount to which the 
election applies shall not exceed:
    (a) The amount of income of the trust (as defined in Sec. 1.643(b)-
1) for the taxable year for which the election is made, or
    (b) The amount of distributable net income of the trust (as defined 
in Secs. 1.643(a)-1 through 1.643(a)-7) for such taxable year, if 
greater,

reduced by any amounts paid, credited, or required to be distributed in 
such taxable year other than those amounts considered paid or credited 
in a preceding taxable year by reason of section 663(b) and this 
section. An election shall be made for each taxable year for which the 
treatment is desired. The application of this paragraph may be 
illustrated by the following example:

    Example. X Trust, a calendar year trust, has $1,000 of income (as 
defined in Sec. 1.643(b)-1) and $800 of distributable net income (as 
defined in Secs. 1.643(a)-1 through 1.643(a)-7) in 1972. The trust 
properly pays $550 to A, a beneficiary, on January 15, 1972, which the 
trustee elects to treat under section 663(b) as paid on December 31, 
1971. The trust also properly pays to A $600 on July 19, 1972, and $450 
on January 17, 1973. For 1972, the maximum amount that may be elected 
under this subdivision to be treated as properly paid or credited on the 
last day of 1972 is $400 ($1,000-$600). The $550 paid on January 15, 
1972, does not reduce the maximum amount to which the election may 
apply, because that amount is treated as properly paid on December 31, 
1971.

    (ii) If an election is made with respect to a taxable year of a 
trust, this section shall apply only to those amounts which are properly 
paid or credited within the first 65 days following such year and which 
are so designated by the fiduciary in his election. Any amount 
considered under section 663(b) as having been distributed in the 
preceding taxable year shall be so treated for all purposes. For 
example, in determining the beneficiary's tax liability, such amount 
shall be considered as having been received by the

[[Page 92]]

beneficiary in his taxable year in which or with which the last day of 
the preceding taxable year of the trust ends.
    (b) Taxable years beginning before January 1, 1969. With respect to 
taxable years of a trust beginning before January 1, 1969, the fiduciary 
of the trust may elect under section 663(b) to treat distributions 
within the first 65 days following such taxable year as amounts which 
were paid or credited on the last day of such taxable year, if:
    (1) The trust was in existence prior to January 1, 1954;
    (2) An amount in excess of the income of the immediately preceding 
taxable year may not (under the terms of the governing instrument) be 
distributed in any taxable year; and
    (3) The fiduciary elects (as provided in Sec. 1.663(b)-2) to have 
section 663(b) apply.

[T.D. 7204, 37 FR 17135, Aug. 25, 1972]



Sec. 1.663(b)-2   Election.

    (a) Manner and time of election; irrevocability--(1) When return is 
required to be filed. If a trust return is required to be filed for the 
taxable year of the trust for which the election is made, the election 
shall be made in the appropriate place on such return. The election 
under this subparagraph shall be made not later than the time prescribed 
by law for filing such return (including extensions thereof). Such 
election shall become irrevocable after the last day prescribed for 
making it.
    (2) When no return is required to be filed. If no return is required 
to be filed for the taxable year of the trust for which the election is 
made, the election shall be made in a statement filed with the internal 
revenue office with which a return by such trust would be filed if such 
trust were required to file a return for such taxable year. See section 
6091 and the regulations thereunder for place for filing returns. The 
election under this subparagraph shall be made not later than the time 
prescribed by law for filing a return if such trust were required to 
file a return for such taxable year. Such election shall become 
irrevocable after the last day prescribed for making it.
    (b) Elections under prior law. Elections made pursuant to section 
663(b) prior to its amendment by section 331(b) of the Tax Reform Act of 
1969 (83 Stat. 598), which, under prior law, were irrevocable for the 
taxable year for which the election was made and all subsequent years, 
are not effective for taxable years beginning after December 31, 1968. 
In the case of a trust for which an election was made under prior law, 
the fiduciary shall make the election for each taxable year beginning 
after December 31, 1968, for which the treatment provided by section 
663(b) is desired.

[T.D. 7204, 37 FR 17135, Aug. 25, 1972]



Sec. 1.663(c)-1   Separate shares treated as separate trusts; in general.

    (a) If a single trust has more than one beneficiary, and if 
different beneficiaries have substantially separate and independent 
shares, their shares are treated as separate trusts for the sole purpose 
of determining the amount of distributable net income allocable to the 
respective beneficiaries under sections 661 and 662. Application of this 
rule will be significant in, for example, situations in which income is 
accumulated for beneficiary A but a distribution is made to beneficiary 
B of both income and corpus in an amount exceeding the share of income 
that would be distributable to B had there been separate trusts. In the 
absence of a separate share rule B would be taxed on income which is 
accumulated for A. The division of distributable net income into 
separate shares will limit the tax liability of B. Section 663(c) does 
not affect the principles of applicable law in situations in which a 
single trust instrument creates not one but several separate trusts, as 
opposed to separate shares in the same trust within the meaning of this 
section.
    (b) The separate share rule does not permit the treatment of 
separate shares as separate trusts for any purpose other than the 
application of distributable net income. It does not, for instance, 
permit the treatment of separate shares as separate trusts for purposes 
of:
    (1) The filing of returns and payment of tax,
    (2) The exclusion of dividends under section 116,
    (3) The deduction of personal exemption under section 642(b), and

[[Page 93]]

    (4) The allowance to beneficiaries succeeding to the trust property 
of excess deductions and unused net operating loss and capital loss 
carryovers on termination of the trust under section 642(h).
    (c) The separate share rule may be applicable even though separate 
and independent accounts are not maintained and are not required to be 
maintained for each share on the books of account of the trust, and even 
though no physical segregation of assets is made or required.
    (d) Separate share treatment is not elective. Thus, if a trust is 
properly treated as having separate and independent shares, such 
treatment must prevail in all taxable years of the trust unless an event 
occurs as a result of which the terms of the trust instrument and the 
requirements of proper administration require different treatment.



Sec. 1.663(c)-2   Computation of distributable net income.

    The amount of distributable net income for any share under section 
663(c) is computed for each share as if each share constituted a 
separate trust. Accordingly, any deduction or any loss which is 
applicable solely to one separate share of the trust is not available to 
any other share of the same trust.



Sec. 1.663(c)-3   Applicability of separate share rule.

    (a) The applicability of the separate share rule provided by section 
663(c) will generally depend upon whether distributions of the trust are 
to be made in substantially the same manner as if separate trusts had 
been created. Thus, if an instrument directs a trustee to divide the 
testator's residuary estate into separate shares (which under applicable 
law do not constitute separate trusts) for each of the testator's 
children and the trustee is given discretion, with respect to each 
share, to distribute or accumulate income or to distribute principal or 
accumulated income, or to do both, separate shares will exist under 
section 663(c). In determining whether separate shares exist, it is 
immaterial whether the principal and any accumulated income of each 
share is ultimately distributable to the beneficiary of such share, to 
his descendants, to his appointees under a general or special power of 
appointment, or to any other beneficiaries (including a charitable 
organization) designated to receive his share of the trust and 
accumulated income upon termination of the beneficiary's interest in the 
share. Thus, a separate share may exist if the instrument provides that 
upon the death of the beneficiary of the share, the share will be added 
to the shares of the other beneficiaries of the trust.
    (b) Separate share treatment will not be applied to a trust or 
portion of a trust subject to a power to: (1) Distribute, apportion, or 
accumulate income, or (2) distribute corpus to or for one or more 
beneficiaries within a group or class of beneficiaries, unless payment 
of income, accumulated income, or corpus of a share of one beneficiary 
cannot affect the proportionate share of income, accumulated income, or 
corpus of any shares of the other beneficiaries, or unless substantially 
proper adjustment must thereafter be made (under the governing 
instrument) so that substantially separate and independent shares exist.
    (c) A share may be considered as separate even though more than one 
beneficiary has an interest in it. For example, two beneficiaries may 
have equal, disproportionate, or indeterminate interests in one share 
which is separate and independent from another share in which one or 
more beneficiaries have an interest. Likewise, the same person may be a 
beneficiary of more than one separate share.
    (d) Separate share treatment may be given to a trust or portion of a 
trust otherwise qualifying under this section if the trust or portion of 
a trust is subject to a power to pay out to a beneficiary of a share (of 
such trust or portion) an amount of corpus in excess of his 
proportionate share of the corpus of the trust if the possibility of 
exercise of the power is remote. For example, if the trust is subject to 
a power to invade the entire corpus for the health, education, support, 
or maintenance of A, separate share treatment is applied if exercise of 
the power requires consideration of A's other income which is so 
substantial as to make the possibility

[[Page 94]]

of exercise of the power remote. If instead it appears that A and B have 
separate shares in a trust, subject to a power to invade the entire 
corpus for the comfort, pleasure, desire, or happiness of A, separate 
share treatment shall not be applied.
    (e) For taxable years ending before December 31, 1978, the separate 
share rule may also be applicable to successive interests in point of 
time, as for instance in the case of a trust providing for a life estate 
to A and a second life estate or outright remainder to B. In such a 
case, in the taxable year of a trust in which a beneficiary dies items 
of income and deduction properly allocable under trust accounting 
principles to the period before a beneficiary's death are attributed to 
one share, and those allocable to the period after the beneficiary's 
death are attributed to the other share. Separate share treatment is not 
available to a succeeding interest, however, with respect to 
distributions which would otherwise be deemed distributed in a taxable 
year of the earlier interest under the throwback provisions of subpart D 
(section 665 and following), part I, subchapter J, chapter 1 of the 
Code. The application of this paragraph may be illustrated by the 
following example:
    Example. A trust instrument directs that the income of a trust is to 
be paid to A for her life. After her death income may be distributed to 
B or accumulated. A dies on June 1, 1956. The trust keeps its books on 
the basis of the calendar year. The trust instrument permits invasions 
of corpus for the benefit of A and B, and an invasion of corpus was in 
fact made for A's benefit in 1956. In determining the distributable net 
income of the trust for the purpose of determining the amounts 
includible in A's income, income and deductions properly allocable to 
the period before A's death are treated as income and deductions of a 
separate share; and for that purpose no account is taken of income and 
deductions allocable to the period after A's death.

    (f) Separate share treatment is not applicable to an estate.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7633, 44 FR 57926, Oct. 9, 1979]



Sec. 1.663(c)-4   Example.

    Section 663(c) may be illustrated by the following example:

    Example. (a) A single trust was created in 1940 for the benefit of 
A, B, and C, who were aged 6, 4, and 2, respectively. Under the terms of 
the instrument, the trust income is required to be divided into three 
equal shares. Each beneficiary's share of the income is to be 
accumulated until he becomes 21 years of age. When a beneficiary reaches 
the age of 21, his share of the income may thereafter be either 
accumulated or distributed to him in the discretion of the trustee. The 
trustee also has discretion to invade corpus for the benefit of any 
beneficiary to the extent of his share of the trust estate, and the 
trust instrument requires that the beneficiary's right to future income 
and corpus will be proportionately reduced. When each beneficiary 
reaches 35 years of age, his share of the trust estate shall be paid 
over to him. The interest in the trust estate of any beneficiary dying 
without issue and before he has attained the age of 35 is to be equally 
divided between the other beneficiaries of the trust. All expenses of 
the trust are allocable to income under the terms of the trust 
instrument.
    (b) No distributions of income or corpus were made by the trustee 
prior to 1955, although A became 21 years of age on June 30, 1954. 
During the taxable year of 1955, the trust has income from royalties of 
$20,000 and expenses of $5,000. The trustee in his discretion 
distributes $12,000 to A. Both A and the trust report on the calendar 
year basis.
    (c) The trust qualifies for the separate share treatment under 
section 663(c) and the distributable net income must be divided into 
three parts for the purpose of determining the amount deductible by the 
trust under section 661 and the amount includible in A's gross income 
under section 662.
    (d) The distributable net income of each share of the trust is 
$5,000 ($6,667 less $1,667). Since the amount ($12,000) distributed to A 
during 1955 exceeds the distributable net income of $5,000 allocated to 
his share, the trust is deemed to have distributed to him $5,000 of 1955 
income and $7,000 of amounts other than 1955 income. Accordingly, the 
trust is allowed a deduction of $5,000 under section 661. The taxable 
income of the trust for 1955 is $9,900, computed as follows:

Royalties.........................................    $20,000           
Deductions:                                                             
  Expenses........................................     $5,000           
  Distribution to A...............................      5,000           
  Personal exemption..............................        100           
                                                    .........     10,100
                                                              ----------
    Taxable income...........................................      9,900
                                                                        

    (e) In accordance with section 662, A must include in his gross 
income for 1955 an amount equal to the portion ($5,000) of the

[[Page 95]]

distributable net income of the trust allocated to his share. Also, the 
excess distribution of $7,000 made by the trust is subject to the 
throwback provisions of subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, and the regulations thereunder.



Sec. 1.664-1  Charitable remainder trusts.

    (a) In general--(1) Introduction--(i) General description of a 
charitable remainder trust. Generally, a charitable remainder trust is a 
trust which provides for a specified distribution, at least annually, to 
one or more beneficiaries, at least one of which is not a charity, for 
life or for a term of years, with an irrevocable remainder interest to 
be held for the benefit of, or paid over to, charity. The specified 
distribution to be paid at least annually must be a sum certain which is 
not less than 5 percent of the initial net fair market value of all 
property placed in trust (in the case of a charitable remainder annuity 
trust) or a fixed percentage which is not less than 5 percent of the net 
fair market value of the trust assets, valued annually (in the case of a 
charitable remainder unitrust). A trust created after July 31, 1969, 
which is a charitable remainder trust is exempt from all of the taxes 
imposed by subtitle A of the Code for any taxable year of the trust 
except a taxable year in which it has unrelated business taxable income.
    (ii) Scope. This section provides definitions, general rules 
governing the creation and administration of a charitable remainder 
trust, and rules governing the taxation of the trust and its 
beneficiaries. For the application of certain foundation rules to 
charitable remainder trusts, see paragraph (b) of this section. If the 
trust has unrelated business taxable income, see paragraph (c) of this 
section. For the treatment of distributions to recipients, see paragraph 
(d) of this section. For the treatment of distributions to charity, see 
paragraph (e) of this section. For the time limitations for amendment of 
governing instruments, see paragraph (f) of this section. For 
transitional rules under which particular requirements are inapplicable 
to certain trusts, see paragraph (g) of this section. Section 1.664-2 
provides rules relating solely to a charitable remainder annuity trust. 
Section 1.664-3 provides rules relating solely to a charitable remainder 
unitrust. Section 1.664-4 provides rules governing the calculation of 
the fair market value of the remainder interest in a charitable 
remainder unitrust. For rules relating to the filing of returns for a 
charitable remainder trust, see paragraph (a)(6) of Sec. 1.6012-3 and 
section 6034 and the regulations thereunder.
    (iii) Definitions. As used in this section and Secs. 1.664-2, 1.664-
3, and 1.664-4:
    (a) Charitable remainder trust. The term charitable remainder trust 
means a trust with respect to which a deduction is allowable under 
section 170, 2055, 2106, or 2522 and which meets the description of a 
charitable remainder annuity trust (as described in Sec. 1.664-2) or a 
charitable remainder unitrust (as described in Sec. 1.664-3).
    (b) Annuity amount. The term annuity amount means the amount 
described in paragraph (a)(1) of Sec. 1.664-2 which is payable, at least 
annually, to the beneficiary of a charitable remainder annuity trust.
    (c) Unitrust amount. The term unitrust amount means the amount 
described in paragraph (a)(1) of Sec. 1.664-3 which is payable, at least 
annually, to the beneficiary of a charitable remainder unitrust.
    (d) Recipient. The term recipient means the beneficiary who receives 
the possession or beneficial enjoyment of the annuity amount or unitrust 
amount.
    (e) Governing instrument. The term governing instrument has the same 
meaning as in section 508(e) and the regulations thereunder.
    (2) Requirement that the trust must be either a charitable remainder 
annuity trust or a charitable remainder unitrust. A trust is a 
charitable remainder trust only if it is either a charitable remainder 
annuity trust in every respect or a charitable remainder unitrust in 
every respect. For example, a trust which provides for the payment each 
year to a noncharitable beneficiary of the greater of a sum certain or a 
fixed percentage of the annual value of the trust assets is not a 
charitable remainder trust inasmuch as the trust is neither a charitable 
remainder annuity trust (for the reason that the payment

[[Page 96]]

for the year may be a fixed percentage of the annual value of the trust 
assets which is not a ``sum certain'') nor a charitable remainder 
unitrust (for the reason that the payment for the year may be a sum 
certain which is not a ``fixed percentage'' of the annual value of the 
trust assets).
    (3) Restrictions on investments. A trust is not a charitable 
remainder trust if the provisions of the trust include a provision which 
restricts the trustee from investing the trust assets in a manner which 
could result in the annual realization of a reasonable amount of income 
or gain from the sale or disposition of trust assets. In the case of 
transactions with, or for the benefit of, a disqualified person, see 
section 4941(d) and the regulations thereunder for rules relating to the 
definition of self-dealing.
    (4) Requirement that trust must meet definition of and function 
exclusively as a charitable remainder trust from its creation. In order 
for a trust to be a charitable remainder trust, it must meet the 
definition of and function exclusively as a charitable remainder trust 
from the creation of the trust. Solely for the purposes of section 664 
and the regulations thereunder, the trust will be deemed to be created 
at the earliest time that neither the grantor nor any other person is 
treated as the owner of the entire trust under subpart E, part 1, 
subchapter J, chapter 1, subtitle A of the Code (relating to grantors 
and others treated as substantial owners), but in no event prior to the 
time property is first transferred to the trust. For purposes of the 
preceding sentence, neither the grantor nor his spouse shall be treated 
as the owner of the trust under such subpart E merely because the 
grantor or his spouse is named as a recipient. See examples 1 through 3 
of subparagraph (6) of this paragraph for illustrations of the foregoing 
rule.
    (5) Rules applicable to testamentary transfers--(i) Deferral of 
annuity or unitrust amount. Notwithstanding subparagraph (4) of this 
paragraph and Secs. 1.664-2 and 1.664-3, for purposes of sections 2055 
and 2106 a charitable remainder trust shall be deemed created at the 
date of death of the decedent (even though the trust is not funded until 
the end of a reasonable period of administration or settlement) if the 
obligation to pay the annuity or unitrust amount with respect to the 
property passing in trust at the death of the decedent begins as of the 
date of death of the decedent, even though the requirement to pay such 
amount is deferred in accordance with the rules provided in this 
subparagraph. If permitted by applicable local law or authorized by the 
provisions of the governing instrument, the requirement to pay such 
amount may be deferred until the end of the taxable year of the trust in 
which occurs the complete funding of the trust. Within a reasonable 
period after such time, the trust must pay (in the case of an 
underpayment) or must receive from the recipient (in the case of an 
overpayment) the difference between:
    (a) Any annuity or unitrust amounts actually paid, plus interest on 
such amounts computed at the rate of interest specified in paragraph 
(a)(5)(iv) of this section, compounded annually, and
    (b) The annuity or unitrust amounts payable, plus interest on such 
amounts computed at the rate of interest specified in paragraph 
(a)(5)(iv) of this section, compounded annually.

The amounts payable shall be retroactively determined by using the 
taxable year, valuation method, and valuation dates which are ultimately 
adopted by the charitable remainder trust. See subdivision (ii) of this 
subparagraph for rules relating to retroactive determination of the 
amount payable under a charitable remainder unitrust. See paragraph 
(d)(4) of this section for rules relating to the year of inclusion in 
the case of an underpayment to a recipient and the allowance of a 
deduction in the case of an overpayment to a recipient.
    (ii) For purposes of retroactively determining the amount under 
subdivision (i)(b) of this subparagraph, the governing instrument of a 
charitable remainder unitrust may provide that the amount described in 
subdivision (i)(b) of this subparagraph with respect to property passing 
in trust at the death of the decedent for the period which begins on the 
date of death of the decedent and ends on the earlier of the date of 
death of the last recipient or the end of the taxable year of the

[[Page 97]]

trust in which occurs the complete funding of the trust shall be 
computed by multiplying:
    (a) The sum of (1) the value, on the earlier of the date of death of 
the last recipient or the last day in such taxable year, of the property 
held in trust which is attributable to property passing to the trust at 
the death of the decedent, (2) any distributions in respect of unitrust 
amounts made by the trust or estate before such date, and (3) interest 
on such distributions computed at the rate of interest specified in 
paragraph (a)(5)(iv) of this section, compounded annually, from the date 
of distribution to such date by:
    (b) (1) In the case of transfers made after November 30, 1983, for 
which the valuation date is before May 1, 1989, a factor equal to 
1.000000 less the factor under the appropriate adjusted payout rate in 
column 2 of Table D in Sec. 1.664-4A(d)(6) opposite the number of years 
in column 1 between the date of death of the decedent and the date of 
the earlier of the death of the last recipient or the last day of such 
taxable year.
    (2) In the case of transfers for which the valuation date is after 
April 30, 1989, a factor equal to 1.000000 less the factor under the 
appropriate adjusted payout rate in Table D in Sec. 1.664-4(e)(6) 
opposite the number of years in column 1 between the date of death of 
the decedent and the date of the earlier of the death of the last 
recipient or the last day of such taxable year. The appropriate adjusted 
payout rate is determined by using the appropriate Table F contained in 
Sec. 1.664-4(e)(6) for the section 7520 rate for the month of the 
valuation date.
    (3) If the number of years between the date of death and the date of 
the earlier of the death of the last recipient or the last day of such 
taxable year is between periods for which factors are provided, a linear 
interpolation must be made.
    (iii) Treatment of distributions. The treatment of a distribution to 
a charitable remainder trust, or to a recipient in respect of an annuity 
or unitrust amount, paid, credited, or required to be distributed by an 
estate, or by a trust which is not a charitable remainder trust, shall 
be governed by the rules of subchapter J, chapter 1, subtitle A of the 
Code other than section 664. In the case of a charitable remainder trust 
which is partially or fully funded during the period of administration 
of an estate or settlement of a trust (which is not a charitable 
remainder trust), the treatment of any amount paid, credited, or 
required to be distributed by the charitable remainder trust shall be 
governed by the rules of section 664.
    (iv) Rate of interest. The following rates of interest shall apply 
for purposes of paragraphs (a)(5) (i) through (iii) of this section:
    (a) The section 7520 rate for the month in which the valuation date 
with respect to the transfer is (or one of the prior two months if 
elected under Sec. 1.7520-2(b)) after April 30, 1989;
    (b) 10 percent for instruments executed or amended (other than in 
the case of a reformation under section 2055(e)(3)) on or after August 
9, 1984, and before May 1, 1989, and not subsequently amended;
    (c) 6 percent or 10 percent for instruments executed or amended 
(other than in the case of a reformation under section 2055(e)(3)) after 
October 24, 1983, and before August 9, 1984; and
    (d) 6 percent for instruments executed before October 25, 1983, and 
not subsequently amended (other than in the case of a reformation under 
section 2055(e)(3)).
    (6) Examples. The application of the rules in paragraphs (a)(4) and 
(a)(5) of this section require the use of actuarial factors contained in 
Sec. 1.664-4(e), Sec. 1.664-4A(d), and former Sec. 1.664-4(d) (as 
contained in the 26 CFR Part 1 edition revised as of April 1, 1994) and 
may be illustrated by use of the following examples:

    Example (1). On September 19, 1971, H transfers property to a trust 
over which he retains an inter vivos power of revocation. The trust is 
to pay W 5 percent of the value of the trust assets, valued annually, 
for her life, remainder to charity. The trust would satisfy all of the 
requirements of section 664 if it were irrevocable. For purposes of 
section 664, the trust is not deemed created in 1971 because H is 
treated as the owner of the entire trust under subpart E. On May 26, 
1975, H predeceases W at which time the trust becomes irrevocable. For 
purposes of section 664, the trust is deemed created on May 26, 1975, 
because that is the earliest date on

[[Page 98]]

which H is not treated as the owner of the entire trust under subpart E. 
The trust becomes a charitable remainder trust on May 26, 1975, because 
it meets the definition of a charitable remainder trust from its 
creation.
    Example (2). The facts are the same as in example (1), except that H 
retains the inter vivos power to revoke only one-half of the trust. For 
purposes of section 664, the trust is deemed created on September 19, 
1971, because on that date the grantor is not treated as the owner of 
the entire trust under subpart E. Consequently, a charitable deduction 
is not allowable either at the creation of the trust or at H's death 
because the trust does not meet the definition of a charitable remainder 
trust from the date of its creation. The trust does not meet the 
definition of a charitable remainder trust from the date of its creation 
because the trust is subject to a partial power to revoke on such date.
    Example (3). The facts are the same as in example (1), except that 
the residue of H's estate is to be paid to the trust and the trust is 
required to pay H's debts. The trust is not a charitable remainder trust 
at H's death because it does not function exclusively as a charitable 
remainder trust from the date of its creation which, in this case, is 
the date it becomes irrevocable.
    Example (4). (i) In 1971, H transfers property to Trust A over which 
he retains an inter vivos power of revocation. Trust A, which is not a 
charitable remainder trust, is to provide income or corpus to W until 
the death of H. Upon H's death the trust is required by its governing 
instrument to pay the debts and administration expenses of H's estate, 
and then to terminate and distribute all of the remaining assets to a 
separate Trust B which meets the definition of a charitable remainder 
annuity trust.
    (ii) Trust B will be charitable remainder trust from the date of its 
funding because it will function exclusively as a charitable remainder 
trust from its creation. For purposes of section 2055, Trust B will be 
deemed created at H's death if the obligation to pay the annuity amount 
begins on the date of H's death. For purposes of section 664, Trust B 
becomes a charitable remainder trust as soon as it is partially or 
completely funded. Consequently, unless Trust B has unrelated business 
taxable income, the income of the trust is exempt from all taxes imposed 
by subtitle A of the Code, and any distributions by the trust, even 
before it is completely funded, are governed by the rules of section 
664. Any distributions made by Trust A, including distributions to a 
recipient in respect of annuity amounts, are governed by the rules of 
subchapter J, chapter 1, subtitle A of the Code other than section 664.
    Example (5). In 1973, H dies testate leaving the net residue of his 
estate (after payment by the estate of all debts and administration 
expenses) to a trust which meets the definition of a charitable 
remainder unitrust. For purposes of section 2055, the trust is deemed 
created at H's death if the requirement to pay the unitrust amount 
begins on H's death and is a charitable remainder trust even though the 
estate is obligated to pay debts and administration expenses.
    For purposes of section 664, the trust becomes a charitable 
remainder trust as soon as it is partially or completely funded. 
Consequently, unless the trust has unrelated business taxable income, 
the income of the trust is exempt from all taxes imposed by subtitle A 
of the Code, and any distributions by the trust, even before it is 
completely funded, are governed by the rules of section 664. Any 
distributions made by H's estate, including distributions to a recipient 
in respect of unitrust amounts, are governed by the rules of subchapter 
J, chapter 1, subtitle A of the Code other than section 664.
    Example (6). (i) On January 1, 1974, H dies testate leaving the 
residue of his estate to a charitable remainder unitrust. The governing 
instrument provides that, beginning at H's death, the trustee is to make 
annual payments to W, on December 31 of each year of 5 percent of the 
net fair market value of the trust assets, valued as of December 31 of 
each year, for W's life and to pay the remainder to charity at the death 
of W. The governing instrument also provides that the actual payment of 
the unitrust amount need not be made until the end of the taxable year 
of the trust in which occurs the complete funding of the trust. The 
governing instrument also provides that the amount payable with respect 
to the period between the date of death and the end of such taxable year 
shall be computed under the special method provided in subparagraph 
(5)(ii) of this paragraph. The governing instrument provides that, 
within a reasonable period after the end of the taxable year of the 
trust in which occurs the complete funding of the trust, the trustee 
shall pay (in the case of an underpayment) or shall receive from the 
recipient (in the case of an overpayment) the difference between the 
unitrust amounts paid (plus interest at 6 percentage compounded 
annually) and the amount computed under the special method. The trust is 
completely funded on September 20, 1976. No amounts were paid before 
June 30, 1977. The trust adopts a fiscal year of July 1 to June 30. The 
net fair market value of the trust assets on June 30, 1977, is $100,000.
    (ii) Because no amounts were paid prior to the end of the taxable 
year in which the trust was completely funded, the amount payable at the 
end of such taxable year is equal to the net fair market value of the 
trust assets on the last day of such taxable year (June 30, 1977) 
multiplied by a factor equal to 1.0 minus the factor in Table D 
corresponding to the number of years in the period between the date of 
death and the end of such taxable year. The adjusted payout rate

[[Page 99]]

(determined under Sec. 1.664-4A(c)) is 5 percent. Because the last day 
of the taxable year in which the trust is completely funded in June 30, 
1977, there are 3 181/365 years in such period. Because there is no 
factor given in Table D for such a period, a linear interpolation must 
be made:

1.0 minus 0.814506 (factor at 5 percent for 4 years)........    0.185494
1.0 minus 0.857375 (factor at 5 percent for 3 years)........     .142625
                                                             -----------
    Difference..............................................     .042869
                    181365=X0.042869                    
                                                                        
                               X=0.021258                               
                                                                        
1.0 minus 0.857375 (factor at 5 percent for 3 years.........    0.142625
Plus: X.....................................................     .021258
                                                             -----------
    Interpolated factor.....................................     .163883
                                                                        

Thus, the amount payable for the period from January 1, 1974, to June 
30, 1977, is $16,388.30 ($100,000 x 0.163883). Thereafter, the trust 
assets must be valued on December 31 of each year and 5 percent of such 
value paid annually to W for her life.

    (b) Application of certain foundation rules to charitable remainder 
trusts. See section 4947(a)(2) and section 4947(b)(3)(B) and the 
regulations thereunder for the application to charitable remainder 
trusts of certain provisions relating to private foundations. See 
section 508(e) for rules relating to required provisions in governing 
instruments prohibiting certain activities specified in section 
4947(a)(2).
    (c) Taxation of nonexempt charitable remainder trusts. If the 
charitable remainder trust has any unrelated business taxable income 
(within the meaning of section 512 and the regulations thereunder, 
determined as if part III, subchapter F, chapter 1, subtitle A of the 
Code applied to such trust) for any taxable year, the trust is subject 
to all of the taxes imposed by subtitle A of the Code for such taxable 
year. For taxable years beginning after December 31, 1969, unrelated 
business taxable income includes debt-financed income. The taxes imposed 
by subtitle A of the Code upon a nonexempt charitable remainder trust 
shall be computed under the rules prescribed by subparts A and C, part 
1, subchapter J, chapter 1, subtitle A of the Code for trusts which may 
accumulate income or which distribute corpus. The provisions of subpart 
E, part 1 of such subchapter J are not applicable with respect to a 
nonexempt charitable remainder trust. The application of the above rules 
may be illustrated by the following example:

    Example. In 1975, a charitable remainder trust which has a calendar 
year as its taxable year has $1,000 of ordinary income, including $100 
of unrelated business taxable income, and no deductions other than under 
sections 642(b) and 661(a). The trust is required to pay out $700 for 
1975 to a noncharitable recipient. Because the trust has some unrelated 
business taxable income in 1975, it is not exempt for such year. 
Consequently, the trust is taxable on all of its income as a complex 
trust. Under section 661(a) of the Code, the trust is allowed a 
deduction of $700. Under section 642(b) of the Code, the trust is 
allowed a deduction of $100. Consequently, the taxable income of the 
trust for 1975 is $200 ($1,000-$700-$100).

    (d) Treatment of annual distributions to recipients--(1) Character 
of distributions--(i) Order of distributions. Annuity and unitrust 
amounts shall be treated as having the following characteristics in the 
hands of the recipients (whether or not the trust is exempt) without 
credit for any taxes which are imposed by subtitle A of the Code on the 
trust:
    (a) Ordinary income. First, as ordinary income to the extent of the 
sum of the trust's ordinary income for the taxable year of the trust and 
its undistributed ordinary income for prior years. An ordinary loss for 
the current year shall be used to reduce undistributed ordinary income 
for prior years and any excess shall be carried forward indefinitely to 
reduce ordinary income for future years. For purposes of this section, 
the amount of current and prior years' income shall be computed without 
regard to the deduction for net operating losses provided by sections 
172 or 642(d).
    (b) Capital gain. Second, as capital gain to the extent of the 
trust's undistributed capital gains. Undistributed capital gains of the 
trust are determined on a cumulative net basis under the rules of this 
subdivision without regard to the provisions of section 1212.
    (1) Long- and short-term capital gains. If, in any taxable year of 
the trust, the trust has both undistributed short-term capital gain and 
undistributed long-term capital gain, then the short

[[Page 100]]

term capital gain shall be deemed distributed prior to any long-term 
capital gain.
    (2) Capital losses in excess of capital gains. If the trust has for 
any taxable year capital losses in excess of capital gains, any excess 
of the net short-term capital loss over the net long-term capital gain 
for such year shall be a short- term capital loss in the succeeding 
taxable year and any excess of the net long-term capital loss over the 
net short-term capital gain for such year shall be a long-term capital 
loss in the succeeding taxable year.
    (3) Capital gains in excess of capital losses. If the trust has for 
any taxable year capital gains in excess of capital losses, any excess 
of the net short-term capital gain over the net long-term capital loss 
for such year shall be, to the extent not deemed distributed, a short-
term capital gain in the succeeding taxable year and any excess of the 
net long-term capital gain over the net short-term capital loss for such 
year shall be, to the extent not deemed distributed, a long-term capital 
gain in the succeeding taxable year.

The application of the rules in this subdivision (b) may be illustrated 
by the following example:

    Example. (i) The X Trust is a charitable remainder trust created on 
January 1, 1975, and has the calendar year as its taxable year. During 
the years indicated, it has the following capital transactions:

1975:                                                                   
  Long-term capital loss....................................         $10
  Short-term capital gain...................................           5
1976:                                                                   
  Short-term capital gain...................................          20
  Short-term capital loss...................................           5
1977:                                                                   
  Long-term capital gain....................................          15
                                                                        

Distributions for 1975 and 1976 were not in excess of current and 
accumulated ordinary income for those years. In 1977, distributions 
exceeded current and accumulated ordinary income by $5.
    (ii) The treatment of the 1975 and 1976 transactions is as follows:

1975:                                                                   
  Long-term capital loss recognized.........................       $(10)
  Short-term capital gain recognized........................           5
                                                             -----------
    Net long-term capital loss carried forward to 1976......         (5)
                                                             ===========
1976:                                                                   
  Short-term capital gain recognized........................          20
  Short-term capital loss recognized........................         (5)
  Long-term capital loss carried forward from 1975..........         (5)
                                                             -----------
    Net short-term capital gain carried forward to 1977.....         $10
                                                             ===========
1977:                                                                   
  Long-term capital gain recognized.........................          15
  Net short-term capital gain carried forward from 1976.....          10
                                                                        

    (iii) In 1977, the trust has long-term capital gain of $15 and 
short-term capital gain of $10. If the trust has both short-term capital 
gain and long-term capital gain for the same taxable year, the short-
term capital gain is deemed distributed prior to the long-term capital 
gain. Therefore, the distribution of $5 in 1977 is deemed to be short-
term capital gain. The undistributed net short-term capital gain of $5 
is a short-term capital gain carried forward to 1978. The undistributed 
net long-term capital gain of $15 is a long-term capital gain carried 
forward to 1978.

    (c) Other income. Third, as other income (including income excluded 
under part III, subchapter B, chapter 1, subtitle A of the Code) to the 
extent of the sum of the trust's other income for the taxable year and 
its undistributed other income for prior years. A loss in this category 
for the current year shall be used to reduce undistributed income in 
such category for prior years and any excess shall be carried forward 
indefinitely to reduce such income for future years.
    (d) Corpus. Finally, as a distribution of trust corpus. For purposes 
of this section, the term corpus means the net fair market value of the 
trust assets less the total undistributed income (but not loss) in each 
of the above categories.
    (ii) Rules relating to character of distributions. The determination 
of the character of amounts distributed shall be made as of the end of 
the taxable year of the trust. Amounts treated as paid from one of the 
categories of income described in (a), (b), or (c) of subdivision (i) of 
this subparagraph shall be treated as consisting of the same proportion 
of each class of items included in such category as the total of the 
current and accumulated income of each class of items bears to the total 
of the current and accumulated income for that category. A loss in one 
of such categories may not be used to reduce a

[[Page 101]]

gain in any other category. The provisions of subparts D and E, part 1, 
subchapter J, chapter 1, subtitle A of the Code are not applicable with 
respect to a charitable remainder trust (regardless of whether the trust 
is exempt).
    (2) Allocation of deductions. Items of deduction of the trust for a 
taxable year of the trust which are deductible in determining taxable 
income (other than the deductions permitted by sections 642(b), 642(c), 
661, and 1202) which are directly attributable to one or more classes of 
items within a category of income or to corpus (determined under 
subparagraph (1)(i) of this paragraph) shall be allocated to such 
classes of items or to corpus. All other allowable deductions for such 
taxable year which are not directly attributable to one or more classes 
of items within a category of income or to corpus (other than the 
deductions permitted by sections 642(b), 642(c), 661, and 1202) shall be 
allocated among the classes of items within the category (excluding 
classes of items with net losses) on the basis of the gross income of 
such classes for such taxable year reduced by the deductions allocated 
thereto under the first sentence of this subparagraph, but in no event 
shall the amount of expenses allocated to any class of items exceed such 
income of such class for the taxable year. Items of deduction which are 
not allocable under the above two sentences (other than the deductions 
permitted by sections 642(b), 642(c), 661, and 1202) may be allocated in 
any manner. All taxes imposed by subtitle A of the Code for which the 
trust is liable because it has unrelated business taxable income and all 
taxes imposed by chapter 42 of the Code shall be allocated to corpus. 
Any expense which is not deductible in determining taxable income and 
which is not allocable to any class of items described in subparagraph 
(1)(i)(c) of this paragraph shall be allocated to corpus. The deductions 
allowable to a trust under sections 642(b), 642(c), 661, and 1202 are 
not allowed in determining the amount or character of any class of items 
within a category of income or corpus in the categories described in 
subparagraph (1) of this paragraph.
    (3) Allocation of income among recipients. If there are two or more 
recipients, each will be treated as receiving his pro rata portion of 
the categories of income and corpus. The application of this rule may be 
illustrated by the following example:

    Example. X transfers $40,000 to a charitable remainder annuity trust 
which is to pay $3,000 per year to X and $2,000 per year to Y for a term 
of 5 years. During the first taxable year the trust has $3,000 of 
ordinary income, $500 of capital gain, and $500 of tax-exempt income 
after allocation of all expenses. X is treated as receiving ordinary 
income of $1,800 ($3,000/$5,000 x $3,000), capital gain of $300 ($3,000/
$5,000 x $500), tax exempt income of $300 ($3,000/$5,000 x $500), and 
corpus of $600 ($3,000/$5,000 x [$5,000-$4,000] ). Y is treated as 
receiving ordinary income of $1,200 ($2,000/$5,000 x $3,000), capital 
gain of $200 ($2,000/$5,000 x $500), tax exempt income of $200 ($2,000/
$5,000 x $500), and corpus of $400 ($2,000/$5,000 x [$5,000-$4,000] ).

    (4) Year of inclusion--(i) General rule. To the extent required by 
this paragraph, the annuity or unitrust amount is includible in the 
recipient's gross income for the taxable year in which the annuity or 
unitrust amount is required to be distributed even though the annuity or 
unitrust amount is not distributed until after the close of the taxable 
year of the trust. If a recipient has a different taxable year (as 
defined in section 441 or 442) from the taxable year of the trust, the 
amount he is required to include in gross income to the extent required 
by this paragraph shall be included in his taxable year in which or with 
which ends the taxable year of the trust in which such amount is 
required to be distributed.
    (ii) Payments resulting from incorrect valuations. Notwithstanding 
subdivision (i) of this subparagraph, any payments which are made or 
required to be distributed by a charitable remainder trust pursuant to 
paragraph (a)(5) of this section, under paragraph (f)(3) of this section 
because of an amendment to the governing instrument, or under paragraphs 
(a)(1) of Secs. 1.664-2 and 1.664-3 because of an incorrect valuation, 
shall, to the extent required by this paragraph, be included in the 
gross income of the recipient in his taxable year in which or with which 
ends the taxable year of the trust in which the amount is paid, 
credited, or required to be distributed. For rules relating to required 
adjustments of underpayments

[[Page 102]]

and overpayments of the annuity or unitrust amounts in respect of 
payments made prior to the amendment of a governing instrument, see 
paragraph (f)(3) of this section. There is allowable to a recipient a 
deduction from gross income for any amounts repaid to the trust because 
of an overpayment during the reasonable period of administration or 
settlement or until the trust is fully funded, because of an amendment, 
or because of an incorrect valuation, to the extent such amounts were 
included in his gross income. See section 1341 and the regulations 
thereunder for rules relating to the computation of tax where a taxpayer 
restores substantial amounts held under a claim of right.
    (iii) Rules applicable to year of recipient's death. If the taxable 
year of the trust does not end with or within the last taxable year of 
the recipient because of the recipient's death, the extent to which the 
annuity or unitrust amount required to be distributed to him is included 
in the gross income of the recipient for his last taxable year, or in 
the gross income of his estate, is determined by making the computations 
required under this paragraph for the taxable year of the trust in which 
his last taxable year ends. (The last sentence of subdivision (i) of 
this subparagraph does not apply to such amounts.) The gross income for 
the last taxable year of a recipient on the cash basis includes (to the 
extent required by this paragraph) amounts actually distributed to the 
recipient before his death. Amounts required to be distributed which are 
distributed to his estate, are included (to the extent required by this 
paragraph) in the gross income of the estate as income in respect of a 
decedent under section 691.
    (5) Distributions in kind. The annuity or unitrust amount may be 
paid in cash or in other property. In the case of a distribution made in 
other property, the amount paid, credited, or required to be distributed 
shall be considered as an amount realized by the trust from the sale or 
other disposition of property. The basis of the property in the hands of 
the recipient is its fair market value at the time it was paid, 
credited, or required to be distributed. The application of these rules 
may be illustrated by the following example:

    Example. On January 1, 1971, X creates a charitable remainder 
annuity trust, whose taxable year is the calendar year, under which X is 
to receive $5,000 per year. During 1971, the trust receives $500 of 
ordinary income. On December 31, 1971, the trust distributed cash of 
$500 and a capital asset of the trust having a fair market value of 
$4,500 and a basis of $2,200. The trust is deemed to have realized a 
capital gain of $2,300. X treats the distribution of $5,000 as being 
ordinary income of $500, capital gain of $2,300 and trust corpus of 
$2,200. The basis of the distributed property is $4,500 in the hands of 
X.

    (e) Other distributions--(1) Character of distributions. An amount 
distributed by the trust to an organization described in section 170(c) 
other than the annuity or unitrust amount shall be considered as a 
distribution of corpus and of those categories of income specified in 
paragraph (d)(1) of this section in an order inverse to that prescribed 
in such paragraph. The character of such amount shall be determined as 
of the end of the taxable year of the trust in which the distribution is 
made after the character of the annuity or unitrust amount has been 
determined.
    (2) Distributions in kind. In the case of a distribution of an 
amount to which subparagraph (1) of this paragraph applies, no gain or 
loss is realized by the trust by reason of a distribution in kind unless 
such distribution is in satisfaction of a right to receive a 
distribution of a specific dollar amount or in specific property other 
than that distributed.
    (f) Effective date--(1) General rule. The provisions of this section 
are effective with respect to transfers in trust made after July 31, 
1969. Any trust created (within the meaning of applicable local law) 
prior to August 1, 1969, is not a charitable remainder trust even if it 
otherwise satisfies the definition of a charitable remainder trust.
    (2) Transfers to pre-1970 trusts. Property transferred to a trust 
created (within the meaning of applicable local law) before August 1, 
1969, whose governing instrument provides that an organization described 
in section 170(c) receives an irrevocable remainder interest in such 
trust, shall, for purposes of subparagraphs (1) and (3) of this 
paragraph, be deemed transferred to a

[[Page 103]]

trust created on the date of such transfer provided that the transfer 
occurs after July 31, 1969, and prior to October 18, 1971, and the 
transferred property and any undistributed income therefrom is severed 
and placed in a separate trust before December 31, 1972, or if later, on 
or before the 30th day after the date on which any judicial proceedings 
begun before December 31, 1972, which are required to sever such 
property, become final.
    (3) Amendment of post-1969 trusts. A trust created (within the 
meaning of applicable local law) subsequent to July 31, 1969, and prior 
to December 31, 1972, which is not a charitable remainder trust at the 
date of its creation, may be treated as a charitable remainder trust 
from the date it would be deemed created under Sec. 1.664-1(a) (4) and 
(5)(i) for all purposes: Provided, That all the following requirements 
are met:
    (i) At the time of the creation of the trust, the governing 
instrument provides that an organization described in section 170(c) 
receives an irrevocable remainder interest in such trust.
    (ii) The governing instrument of the trust is amended so that the 
trust will meet the definition of a charitable remainder trust and, if 
applicable, will meet the requirement of paragraph (a)(5)(i) of this 
section that obligation to make payment of the annuity or unitrust 
amount with respect to property passing at death begin as of the date of 
death, before December 31, 1972, or if later, on or before the 30th day 
after the date on which any judicial proceedings which are begun before 
December 31, 1972, and which are required to amend its governing 
instrument, become final. In the case of a trust created (within the 
meaning of applicable local law) subsequent to July 31, 1969, and prior 
to December 31, 1972, the provisions of section 508(d)(2)(A) shall not 
apply if the governing instrument of the trust is amended so as to 
comply with the requirements of section 508(e) before December 31, 1972, 
or if later, on or before the 30th day after the date on which any 
judicial proceedings which are begun before December 31, 1972, and which 
are required to amend its governing instrument, become final. 
Notwithstanding the provisions of paragraphs (a)(3) and (a)(4) of 
Secs. 1.664-2 and 1.664-3, the governing instrument may grant to the 
trustee a power to amend the governing instrument for the sole purpose 
of complying with the requirements of this section and Sec. 1.664-2 or 
Sec. 1.664-3: Provided, That at the creation of the trust, the governing 
instrument (a) provides for the payment of a unitrust amount described 
in Sec. 1.664-3(a)(1)(i) or an annuity which meets the requirements of 
paragraph (a)(2) of Sec. 1.664-2 or Sec. 1.664-3, (b) designates the 
recipients of the trust and the period for which the amount described in 
(a) of this subdivision (ii) is to be paid, and (c) provides that an 
organization described in section 170(c) receives an irrevocable 
remainder interest in such trust. The mere granting of such a power is 
not sufficient to meet the requirements of this subparagraph that the 
governing instrument be amended in the manner and within the time 
limitations of this subparagraph.
    (iii)(a) Where the amount of the distributions which would have been 
made by the trust to a recipient if the amended provisions of such trust 
had been in effect from the time of creation of such trust exceeds the 
amount of the distributions made by the trust prior to its amendment, 
the trust pays an amount equal to such excess to the recipient.
    (b) Where the amount of distributions made to the recipient prior to 
the amendment of the trust exceeds the amount of the distributions which 
would have been made by such trust if the amended provisions of such 
trust had been in effect from the time of creation of such trust, such 
excess is repaid to the trust by the recipient.

See paragraph (d)(4) of this section for rules relating to the year of 
inclusion in the case of an underpayment to a recipient and the 
allowance of a deduction in the case of an overpayment to a recipient. A 
deduction for a transfer to a charitable remainder trust shall not be 
allowed until the requirements of this paragraph are met and then only 
if the deduction is claimed on a timely filed return (including 
extensions) or on a claim for refund filed within the period of 
limitations prescribed by section 6511(a).

[[Page 104]]

    (g) Transitional effective date. Notwithstanding any other provision 
of this section, Sec. 1.664-2 or Sec. 1.664-3, the requirement of 
paragraph (a)(5)(i) of this section that interest accrue on overpayments 
and underpayments, the requirement of paragraph (a)(5)(ii) of this 
section that the unitrust amount accruing under the formula provided 
therein cease with the death of the last recipient, and the requirement 
that the governing instrument of the trust contain the provisions 
specified in paragraph (a)(1)(iv) of Sec. 1.664-2 (relating to 
computation of the annuity amount in certain circumstances), paragraph 
(a)(1)(v) of Sec. 1.664-3 (relating to computation of the unitrust 
amount in certain circumstances), paragraphs (b) of Secs. 1.664-2 and 
1.664-3 (relating to additional contributions), and paragraph 
(a)(1)(iii) of Sec. 1.664-3 (relating to incorrect valuations), 
paragraphs (a)(6)(iv) of Secs. 1.664-2 and 1.664-3 (relating to 
alternative remaindermen) shall not apply to:
    (1) A will executed on or before December 31, 1972, if:
    (i) The testator dies before December 31, 1975, without having 
republished the will after December 31, 1972, by codicil or otherwise.
    (ii) The testator at no time after December 31, 1972, had the right 
to change the provisions of the will which pertain to the trust, or
    (iii) The will is not republished by codicil or otherwise before 
December 31, 1975, and the testator is on such date and at all times 
thereafter under a mental disability to republish the will by codicil or 
otherwise, or
    (2) A trust executed on or before December 31, 1972, if:
    (i) The grantor dies before December 31, 1975, without having 
amended the trust after December 31, 1972,
    (ii) The trust is irrevocable on December 31, 1972, or
    (iii) The trust is not amended before December 31, 1975, and the 
grantor is on such date and at all times thereafter under a mental 
disability to change the terms of the trust.

[T.D. 7202, 37 FR 16913, Aug. 23, 1972; 37 FR 28288, Dec. 22, 1972, as 
amended by T.D. 7955, 49 FR 19983, May 11, 1984; T.D. 8540, 59 FR 30102, 
30116, June 10, 1994]



Sec. 1.664-2  Charitable remainder annuity trust.

    (a) Description. A charitable remainder annuity trust is a trust 
which complies with the applicable provisions of Sec. 1.664-1 and meets 
all of the following requirements:
    (1) Required payment of annuity amount--(i) Payment of sum certain 
at least annually. The governing instrument provides that the trust 
shall pay a sum certain not less often than annually to a person or 
persons described in subparagraph (3) of this paragraph for each taxable 
year of the period specified in subparagraph (5) of this paragraph. The 
trust will not be deemed to have engaged in an act of self-dealing 
(within the meaning of section 4941), to have unrelated debt-financed 
income (within the meaning of section 514), to have received an 
additional contribution (within the meaning of Sec. 1.664-2(b) ), or to 
have failed to function exclusively as a charitable remainder trust 
(within the meaning of Sec. 1.664-1(a)(4) ) merely because payment of 
the annuity amount is made after the close of the taxable year: 
Provided, That such payment is made within a reasonable time after the 
close of such taxable year. For purposes of the preceding sentence, a 
reasonable time will not ordinarily extend beyond the date by which the 
trustee is required to file Form 1041-B (including extensions) for such 
year.
    (ii) Definition of sum certain. A sum certain is a stated dollar 
amount which is the same either as to each recipient or as to the total 
amount payable for each year of such period. For example, a provision 
for an amount which is the same every year to A until his death and 
concurrently an amount which is the same every year to B until his 
death, with the amount to each recipient to terminate at his death, 
would satisfy the above rule. Similarly, provisions for an amount to A 
and B for their joint lives and then to the survivor would satisfy the 
above rule. In the case of a distribution to an organization described 
in section 170(c) at the death of a recipient or the expiration of a 
term of years, the governing instrument may provide for a reduction of 
the stated amount payable after such a distribution: Provided, That:

[[Page 105]]

    (a) The reduced amount payable is the same either as to each 
recipient or as to the total amount payable for each year of the balance 
of such period, and
    (b) The requirements of subparagraph (2)(ii) of this paragraph are 
met.
    (iii) Sum certain stated as a fraction or percentage. The stated 
dollar amount may be expressed as a fraction or a percentage of the 
initial net fair market value of the property irrevocably passing in 
trust as finally determined for Federal tax purposes. If the stated 
dollar amount is so expressed and such market value is incorrectly 
determined by the fiduciary, the requirement of this subparagraph will 
be satisfied if the governing instrument provides that in such event the 
trust shall pay to the recipient (in the case of an undervaluation) or 
be repaid by the recipient (in the case of an overvaluation) an amount 
equal to the difference between the amount which the trust should have 
paid the recipient if the correct value were used and the amount which 
the trust actually paid the recipient. Such payments or repayments must 
be made within a reasonable period after the final determination of such 
value. Any payment due to a recipient by reason of such incorrect 
valuation shall be considered to be a payment required to be distributed 
at the time of such final determination for purposes of paragraph 
(d)(4)(ii) of Sec. 1.664-1. See paragraph (d)(4) of Sec. 1.664-1 for 
rules relating to the year of inclusion of such payments and the 
allowance of a deduction for such repayments. See paragraph (b) of this 
section for rules relating to future contributions. For rules relating 
to required adjustments for underpayments or overpayments of the amount 
described in this paragraph in respect of payments made during a 
reasonable period of administration, see paragraph (a)(5) of Sec. 1.664-
1. The application of the rule permitting the stated dollar amount to be 
expressed as a fraction or a percentage of the initial net fair market 
value of the property irrevocably passing in trust as finally determined 
for Federal tax purposes may be illustrated by the following example:

    Example. The will of X provides for the transfer of one-half of his 
residuary estate to a charitable remainder annuity trust which is 
required to pay to W for life an annuity equal to 5 percent of the 
initial net fair market value of the interest passing in trust as 
finally determined for Federal tax purposes. The annuity is to be paid 
on December 31 of each year computed from the date of X's death. The 
will also provides that if such initial net fair market value is 
incorrectly determined, the trust shall pay to W, in the case of an 
undervaluation, or be repaid by W, in the case of an overvaluation, an 
amount equal to the difference between the amount which the trust should 
have paid if the correct value were used and the amount which the trust 
actually paid. X dies on March 1, 1971. The executor files an estate tax 
return showing the value of the residuary estate as $250,000 before 
reduction for taxes and expenses of $50,000. The executor paid to W 
$4,192 ([$250,000- $50,000] x 1/2 x 5 percent x 306/365) on December 31, 
1971. On January 1, 1972, the executor transfers one-half of the residue 
of the estate to the trust. The trust adopts the calendar year as its 
taxable year. The value of the residuary estate is finally determined 
for Federal tax purposes to be $240,000 ($290,000-$50,000). Accordingly, 
the amount which the executor should have paid to W is $5,030 ( 
[$290,000-$50,000] x  1/2 x 5 percent x 306/365). Consequently, an 
additional amount of $838 ($5,030-$4,192) must be paid to W within a 
reasonable period after the final determination of value for Federal tax 
purposes.

    (iv) Computation of annuity amount in certain circumstances--(a) 
Short taxable years. The governing instrument provides that, in the case 
of a taxable year which is for a period of less than 12 months other 
than the taxable year in which occurs the end of the period specified in 
subparagraph (5) of this paragraph, the annuity amount determined under 
subdivision (i) of this subparagraph shall be the amount otherwise 
determined under that subdivision multiplied by a fraction the numerator 
of which is the number of days in the taxable year of the trust and the 
denominator of which is 365 (366 if February 29 is a day included in the 
numerator).
    (b) Last taxable year of period. The governing instrument provides 
that, in the case of the taxable year in which occurs the end of the 
period specified in subparagraph (5) of this paragraph, the annuity 
amount which must be distributed under subdivision (i) of this 
subparagraph shall be the amount otherwise determined under that 
subdivision multiplied by a fraction the numerator of which is the 
number of days

[[Page 106]]

in the period beginning on the first day of such taxable year and ending 
on the last day of the period specified in subparagraph (5) of this 
paragraph and the denominator of which is 365 (366 if February 29 is a 
day included in the numerator). See subparagraph (5) of this paragraph 
for a special rule allowing termination of payment of the annuity amount 
with the regular payment next preceding the termination of the period 
specified therein.
    (2) Minimum annuity amount--(i) General rule. The total amount 
payable under subparagraph (1) of this paragraph is not less than 5 
percent of the initial net fair market value of the property placed in 
trust as finally determined for Federal tax purposes.
    (ii) Reduction of annuity amount in certain cases. A trust will not 
fail to meet the requirements of this subparagraph by reason of the fact 
that it provides for a reduction of the stated amount payable upon the 
death of a recipient or the expiration of a term of years provided that:
    (a) A distribution is made to an organization described in section 
170(c) at the death of such recipient or the expiration of such term of 
years, and
    (b) The total amounts payable each year under subparagraph (1) of 
this paragraph after such distribution are not less than a stated dollar 
amount which bears the same ratio to 5 percent of the initial net fair 
market value of the trust assets as the net fair market value of the 
trust assets immediately after such distribution bears to the net fair 
market value of the trust assets immediately before such distribution.
    (iii) Rule applicable to inter vivos trust which does not provide 
for payment of minimum annuity amount. In the case where the grantor of 
an inter vivos trust underestimates in good faith the initial net fair 
market value of the property placed in trust as finally determined for 
Federal tax purposes and specifies a fixed dollar amount for the annuity 
which is less than 5 percent of the initial net fair market value of the 
property placed in trust as finally determined for Federal tax purposes, 
the trust will be deemed to have met the 5 percent requirement if the 
grantor or his representative consents, by appropriate agreement with 
the District Director, to accept an amount equal to 20 times the annuity 
as the fair market value of the property placed in trust for purposes of 
determining the appropriate charitable contributions deduction.
    (3) Permissible recipients--(i) General rule. The amount described 
in subparagraph (1) of this paragraph is payable to or for the use of a 
named person or persons, at least one of which is not an organization 
described in section 170(c). If the amount described in subparagraph (1) 
of this paragraph is to be paid to an individual or individuals, all 
such individuals must be living at the time of the creation of the 
trust. A named person or persons may include members of a named class 
provided that, in the case of a class which includes any individual, all 
such individuals must be alive and ascertainable at the time of the 
creation of the trust unless the period for which the annuity amount is 
to be paid to such class consists solely of a term of years. For 
example, in the case of a testamentary trust, the testator's will may 
provide that an amount shall be paid to his children living at his 
death.
    (ii) Power to alter amount paid to recipients. A trust is not a 
charitable remainder annuity trust if any person has the power to alter 
the amount to be paid to any named person other than an organization 
described in section 170(c) if such power would cause any person to be 
treated as the owner of the trust, or any portion thereof, if subpart E, 
part 1, subchapter J, chapter 1, subtitle A of the Code were applicable 
to such trust. See paragraph (a)(4) of this section for a rule 
permitting the retention by a grantor of a testamentary power to revoke 
or terminate the interest of any recipient other than an organization 
described in section 170(c). For example, the governing instrument may 
not grant the trustee the power to allocate the annuity among members of 
a class unless such power falls within one of the exceptions to section 
674(a).
    (4) Other payments. No amount other than the amount described in 
subparagraph (1) of this paragraph may be paid to or for the use of any 
person other than an organization described in section 170(c). An amount 
is not paid to or

[[Page 107]]

for the use of any person other than an organization described in 
section 170(c) if the amount is transferred for full and adequate 
consideration. The trust may not be subject to a power to invade, alter, 
amend, or revoke for the beneficial use of a person other than an 
organization described in section 170(c). Notwithstanding the preceding 
sentence, the grantor may retain the power exercisable only by will to 
revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). The governing instrument may 
provide that any amount other than the amount described in subparagraph 
(1) of this paragraph shall be paid (or may be paid in the discretion of 
the trustee) to an organization described in section 170(c) provided 
that in the case of distributions in kind, the adjusted basis of the 
property distributed is fairly representative of the adjusted basis of 
the property available for payment on the date of payment. For example, 
the governing instrument may provide that a portion of the trust assets 
may be distributed currently, or upon the death of one or more 
recipients, to an organization described in section 170(c).
    (5) Period of payment of annuity amount--(i) General rules. The 
period for which an amount described in subparagraph (1) of this 
paragraph is payable begins with the first year of the charitable 
remainder trust and continues either for the life or lives of a named 
individual or individuals or for a term of years not to exceed 20 years. 
Only an individual or an organization described in section 170(c) may 
receive an amount for the life of an individual. If an individual 
receives an amount for life, it must be solely for his life. Payment of 
the amount described in subparagraph (1) of this paragraph may terminate 
with the regular payment next preceding the termination of the period 
described in this subparagraph. The fact that the recipient may not 
receive such last payment shall not be taken into account for purposes 
of determining the present value of the remainder interest. In the case 
of an amount payable for a term of years, the length of the term of 
years shall be ascertainable with certainty at the time of the creation 
of the trust, except that the term may be terminated by the death of the 
recipient or by the grantor's exercise by will of a retained power to 
revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). In any event, the period may 
not extend beyond either the life or lives of a named individual or 
individuals or a term of years not to exceed 20 years. For example, the 
governing instrument may not provide for the payment of an annuity 
amount to A for his life and then to B for a term of years because it is 
possible for the period to last longer than either the lives of 
recipients in being at the creation of the trust or a term of years not 
to exceed 20 years. On the other hand, the governing instrument may 
provide for the payment of an annuity amount to A for his life and then 
to B for his life or a term of years (not to exceed 20 years), whichever 
is shorter (but not longer), if both A and B are in being at the 
creation of the trust because it is not possible for the period to last 
longer than the lives of recipients in being at the creation of the 
trust.
    (ii) Relationship to 5 percent requirement. The 5 percent 
requirement provided in subparagraph (2) of this paragraph must be met 
until the termination of all of the payments described in subparagraph 
(1) of this paragraph. For example, the following provisions would 
satisfy the above rules:
    (a) An amount equal to at least 5 percent of the initial net fair 
market value of the property placed in trust to A and B for their joint 
lives and then to the survivor for his life;
    (b) An amount equal to at least 5 percent of the initial net fair 
market value of the property placed in trust to A for life or for a term 
of years not longer than 20 years, whichever is longer (or shorter);
    (c) An amount equal to at least 5 percent of the initial net fair 
market value of the property placed in trust to A for a term of years 
not longer than 20 years and then to B for life (provided B was living 
at the date of creation of the trust);
    (d) An amount to A for his life and concurrently an amount to B for 
his life (the amount to each recipient to terminate at his death) if the 
amount

[[Page 108]]

given to each individual is not less than 5 percent of the initial net 
fair market value of the property placed in trust; or
    (e) An amount to A for his life and concurrently an equal amount to 
B for his life, and at the death of the first to die, the trust to 
distribute one-half of the then value of its assets to an organization 
described in section 170(c), if the total of the amounts given to A and 
B is not less than 5 percent of the initial net fair market value of the 
property placed in trust.
    (6) Permissible remaindermen--(i) General rule. At the end of the 
period specified in subparagraph (5) of this paragraph the entire corpus 
of the trust is required to be irrevocably transferred, in whole or in 
part, to or for the use of one or more organizations described in 
section 170(c) or retained, in whole or in part, for such use.
    (ii) Treatment of trust. If all of the trust corpus is to be 
retained for such use, the taxable year of the trust shall terminate at 
the end of the period specified in subparagraph (5) of this paragraph 
and the trust shall cease to be treated as a charitable remainder trust 
for all purposes. If all or any portion of the trust corpus is to be 
transferred to or for the use of such organization or organizations, the 
trustee shall have a reasonable time after the period specified in 
subparagraph (5) of this paragraph to complete the settlement of the 
trust. During such time, the trust shall continue to be treated as a 
charitable remainder trust for all purposes, such as sections 664, 
4947(a)(2), and 4947(b)(3)(B). Upon the expiration of such period, the 
taxable year of the trust shall terminate and the trust shall cease to 
be treated as a charitable remainder trust for all purposes. If the 
trust continues in existence, it will be subject to the provisions of 
section 4947(a)(1) unless the trust is exempt from taxation under 
section 501(a). For purposes of determining whether the trust is exempt 
under section 501(a) as an organization described in section 501(c)(3), 
the trust shall be deemed to have been created at the time it ceases to 
be treated as a charitable remainder trust.
    (iii) Concurrent or successive remaindermen. Where interests in the 
corpus of the trust are given to more than one organization described in 
section 170(c) such interests may be enjoyed by them either concurrently 
or successively.
    (iv) Alternative remaindermen. The governing instrument shall 
provide that if an organization to or for the use of which the trust 
corpus is to be transferred or for the use of which the trust corpus is 
to be retained is not an organization described in section 170(c) at the 
time any amount is to be irrevocably transferred to or for the use of 
such organization, such amount shall be transferred to or for the use of 
one or more alternative organizations which are described in section 
170(c) at such time or retained for such use. Such alternative 
organization or organizations may be selected in any manner provided by 
the terms of the governing instrument.
    (b) Additional contributions. A trust is not a charitable remainder 
annuity trust unless its governing instrument provides that no 
additional contributions may be made to the charitable remainder annuity 
trust after the initial contribution. For purposes of this section, all 
property passing to a charitable remainder annuity trust by reason of 
death of the grantor shall be considered one contribution.
    (c) Calculation of the fair market value of the remainder interest 
of a charitable remainder annuity trust. For purposes of sections 170, 
2055, 2106, and 2522, the fair market value of the remainder interest of 
a charitable remainder annuity trust (as described in this section) is 
the net fair market value (as of the appropriate valuation date) of the 
property placed in trust less the present value of the annuity. For 
purposes of this section, valuation date means, in general, the date on 
which the property is transferred to the trust by the donor regardless 
of when the trust is created. In the case of transfers to a charitable 
remainder annuity trust for which the valuation date is after April 30, 
1989, if an election is made under section 7520 and Sec. 1.7520-2(b) to 
compute the present value of the charitable interest by use of the 
interest rate component for either of the 2 months preceding the month 
in which the transfer is made, the month so elected is the valuation

[[Page 109]]

date for purposes of determining the interest rate and mortality tables. 
For purposes of section 2055 or 2106, the valuation date is the date of 
death unless the alternate valuation date is elected in accordance with 
section 2032, in which event, and within the limitations set forth in 
section 2032 and the regulations thereunder, the valuation date is the 
alternate valuation date. If the decedent's estate elects the alternate 
valuation date under section 2032 and also elects, under section 7520 
and Sec. 1.7520-2(b), to use the interest rate component for one of the 
2 months preceding the alternate valuation date, the month so elected is 
the valuation date for purposes of determining the interest rate and 
mortality tables. The present value of an annuity is computed under 
Sec. 20.2031-7(d) of this chapter (Estate Tax Regulations) for transfers 
for which the valuation date is after April 30, 1989, or under 
Sec. 20.2031-7A (a) through (d) of this chapter, whichever is 
applicable, for transfers for which the valuation date is before May 1, 
1989. See, however, Sec. 1.7520-3(b) (relating to exceptions to the use 
of prescribed tables under certain circumstances). If the valuation date 
of a transfer to a charitable remainder annuity trust is after April 30, 
1989, and before June 10, 1994, a transferor can rely on Notice 89-24, 
1989-1 C.B. 660, or Notice 89-60, 1989-1 C.B. 700 (See 
Sec. 601.601(d)(2)(ii)(b) of this chapter), in valuing the transferred 
interest.
    (d) Deduction for transfers to a charitable remainder annuity trust. 
For rules relating to a deduction for transfers to a charitable 
remainder annuity trust, see section 170, 2055, 2106, or 2522 and the 
regulations thereunder. Any claim for deduction on any return for the 
value of a remainder interest in a charitable remainder annuity trust 
must be supported by a full statement attached to the return showing the 
computation of the present value of such interest. The deduction allowed 
by section 170 is limited to the fair market value of the remainder 
interest of a charitable remainder annuity trust regardless of whether 
an organization described in section 170(c) also receives a portion of 
the annuity. For a special rule relating to the reduction of the amount 
of a charitable contribution deduction with respect to a contribution of 
certain ordinary income property or capital gain property, see section 
170(e)(1)(A) or 170(e)(1)(B)(i) and the regulations thereunder. For 
rules for postponing the time for deduction of a charitable contribution 
of a future interest in tangible personal property, see section 
170(a)(3) and the regulations thereunder.

[T.D. 7202, 37 FR 16918, Aug. 23, 1972, as amended by T.D. 7955, 49 FR 
19983, May 11, 1984; T.D. 8540, 59 FR 30116, June 10, 1994]



Sec. 1.664-3  Charitable remainder unitrust.

    (a) Description. A charitable remainder unitrust is a trust which 
complies with the applicable provisions of Sec. 1.664-1 and meets all of 
the following requirements:
    (1) Required payment of unitrust amount--(i) Payment of fixed 
percentage at least annually--(a) General rule. The governing instrument 
provides that the trust shall pay not less often than annually a fixed 
percentage of the net fair market value of the trust assets determined 
annually to a person or persons described in subparagraph (3) of this 
paragraph for each taxable year of the period specified in subparagraph 
(5) of this paragraph. The trust will not be deemed to have engaged in 
an act of self-dealing (within the meaning of section 4941), to have 
unrelated debt-financed income (within the meaning of section 4941), to 
have received an additional contribution (within the meaning of 
Sec. 1.664-3(b)), or to have failed to function exclusively as a 
charitable remainder trust (within the meaning of Sec. 1.664-1(a)(4)) 
merely because payment of the unitrust amount is made after the close of 
the taxable year: Provided, That such payment is made within a 
reasonable time after the close of such taxable year. For purposes of 
the preceding sentence, a reasonable time will not ordinarily extend 
beyond the date by which the trustee is required to file Form 1041-B 
(including extensions) for such year.
    (b) Income exception. Instead of the amount described in (a) of this 
subdivision (i), the governing instrument may provide that the trust 
shall pay for any year either the amount described in (1)

[[Page 110]]

or the total of the amounts described in (1) and (2) of this subdivision 
(b).
    (1) The amount of trust income (as defined in section 643(b) and the 
regulations thereunder), for a taxable year to the extent that such 
amount is not more than the amount required to be distributed under (a) 
of this subdivision (i).
    (2) An amount of trust income for a taxable year which is in excess 
of the amount required to be distributed under (a) of this subdivision 
(i) for such year, to the extent that (by reason of (1)) the aggregate 
of the amounts paid in prior years was less than the aggregate of such 
required amounts.
    (ii) Definition of fixed percentage. The fixed percentage may be 
expressed either as a fraction or as a percentage and must be payable 
each year in the period specified in subparagraph (5) of this paragraph. 
A percentage is fixed if the percentage is the same either as to each 
recipient or as to the total percentage payable each year of such 
period. For example, provision for a fixed percentage which is the same 
every year to A until his death and concurrently a fixed percentage 
which is the same every year to B until his death, the fixed percentage 
to each recipient to terminate at his death, would satisfy the rule. 
Similarly, provision for a fixed percentage to A and B for their joint 
lives and then to the survivor would satisfy the rule. In the case of a 
distribution to an organization described in section 170(c) at the death 
of a recipient or the expiration of a term of years, the governing 
instrument may provide for a reduction of the fixed percentage payable 
after such distribution Provided That:
    (a) The reduced fixed percentage is the same either as to each 
recipient or as to the total amount payable for each year of the balance 
of such period, and
    (b) The requirements of subparagraph (2)(ii) of this paragraph are 
met.
    (iii) Rules applicable to incorrect valuations. The governing 
instrument provides that in the case where the net fair market value of 
the trust assets is incorrectly determined by the fiduciary, the trust 
shall pay to the recipient (in the case of an undervaluation) or be 
repaid by the recipient (in the case of an overvaluation) an amount 
equal to the difference between the amount which the trust should have 
paid the recipient if the correct value were used and the amount which 
the trust actually paid the recipient. Such payments or repayments must 
be made within a reasonable period after the final determination of such 
value. Any payment due to a recipient by reason of such incorrect 
valuation shall be considered to be a payment required to be distributed 
at the time of such final determination for purposes of paragraph 
(d)(4)(ii) of Sec. 1.664-1. See paragraph (d)(4) of Sec. 1.664-1 for 
rules relating to the year of inclusion of such payments and the 
allowance of a deduction for such repayments. See paragraph (b) of this 
section for rules relating to additional contributions.
    (iv) Rules applicable to valuation. In computing the net fair market 
value of the trust assets there shall be taken into account all assets 
and liabilities without regard to whether particular items are taken 
into account in determining the income of the trust. The net fair market 
value of the trust assets may be determined on any one date during the 
taxable year of the trust, or by taking the average of valuations made 
on more than one date during the taxable year of the trust, so long as 
the same valuation date or dates and valuation methods are used each 
year. If the governing instrument does not specify the valuation date or 
dates, the trustee shall select such date or dates and shall indicate 
his selection on the first return on Form 1041-B which the trust is 
required to file. The amount described in subdivision (i)(a) of this 
subparagraph which must be paid each year must be based upon the 
valuation for such year.
    (v) Computation of unitrust amount in certain circumstances--(a) 
Short taxable years. The governing instrument provides that, in the case 
of a taxable year which is for a period of less than 12 months other 
than the taxable year in which occurs the end of the period specified in 
subparagraph (5) of this paragraph:
    (1) The amount determined under subdivision (i)(a) of this 
subparagraph shall be the amount otherwise determined under that 
subdivision multiplied by a fraction the numerator of

[[Page 111]]

which is the number of days in the taxable year of the trust and the 
denominator of which is 365 (366 if February 29 is a day included in the 
numerator),
    (2) The amount determined under subdivision (i)(b) of this 
subparagraph shall be computed by using the amount determined under 
subdivision (a)(1) of this subdivision (v), and
    (3) If no valuation date occurs before the end of the taxable year 
of the trust, the trust assets shall be valued as of the last day of the 
taxable year of the trust.
    (b) Last taxable year of period. (1) The governing instrument 
provides that, in the case of the taxable year in which occurs the end 
of the period specified in subparagraph (5) of this paragraph:
    (i) The unitrust amount which must be distributed under subdivision 
(i)(a) of this subparagraph shall be the amount otherwise determined 
under that subdivision multiplied by a fraction the numerator of which 
is the number of days in the period beginning on the first day of such 
taxable year and ending on the last day of the period specified in 
subparagraph (5) of this paragraph and the denominator of which is 365 
(366 if February 29 is a day included in the numerator),
    (ii) The amount determined under subdivision (i)(b) of this 
subparagraph shall be computed by using the amount determined under 
(b)(1)(i) of this subdivision (v), and
    (iii) If no valuation date occurs before the end of such period, the 
trust assets shall be valued as of the last day of such period.
    (2) See subparagraph (5) of this paragraph for a special rule 
allowing termination of payment of the unitrust amount with the regular 
payment next preceding the termination of the period specified therein.
    (2) Minimum unitrust amount--(i) General rule. The fixed percentage 
described in subparagraph (1)(i) of this paragraph with respect to all 
beneficiaries taken together is not less than 5 percent.
    (ii) Reduction of unitrust amount in certain cases. A trust will not 
fail to meet the requirements of this subparagraph by reason of the fact 
that it provides for a reduction of the fixed percentage payable upon 
the death of a recipient or the expiration of a term of years Provided 
That:
    (a) A distribution is made to an organization described in section 
170(c) at the death of such recipient or the expiration of such term of 
years, and
    (b) The total of the percentage payable under subparagraph (1) of 
this paragraph after such distribution is not less than 5 percent.
    (3) Permissible recipients--(i) General rule. The amount described 
in subparagraph (1) of this paragraph is payable to or for the use of a 
named person or persons, at least one of which is not an organization 
described in section 170(c). If the amount described in subparagraph (1) 
of this paragraph is to be paid to an individual or individuals, all 
such individuals must be living at the time of creation of the trust. A 
named person or persons may include members of a named class except in 
the case of a class which includes any individual, all such individuals 
must be alive and ascertainable at the time of the creation of the trust 
unless the period for which the unitrust amount is to be paid to such 
class consists solely of a term of years. For example, in the case of a 
testamentary trust, the testator's will may provide that the required 
amount shall be paid to his children living at his death.
    (ii) Power to alter amount paid to recipients. A trust is not a 
charitable remainder unitrust if any person has the power to alter the 
amount to be paid to any named person other than an organization 
described in section 170(c) if such power would cause any person to be 
treated as the owner of the trust, or any portion thereof, if subpart E, 
part 1, subchapter J, chapter 1, subtitle A of the Code were applicable 
to such trust. See paragraph (a)(4) of this section for a rule 
permitting the retention by a grantor of a testamentary power to revoke 
or terminate the interest of any recipient other than an organization 
described in section 170(c). For example, the governing instrument may 
not grant the trustee the power to allocate the fixed percentage among 
members of a class unless such power falls within one of the exceptions 
to section 674(a).

[[Page 112]]

    (4) Other payments. No amount other than the amount described in 
subparagraph (1) of this paragraph may be paid to or for the use of any 
person other than an organization described in section 170(c). An amount 
is not paid to or for the use of any person other than an organization 
described in section 170(c) if the amount is transferred for full and 
adequate consideration. The trust may not be subject to a power to 
invade, alter, amend, or revoke for the beneficial use of a person other 
than an organization described in section 170(c). Notwithstanding the 
preceding sentence, the grantor may retain the power exercisable only by 
will to revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). The governing instrument may 
provide that any amount other than the amount described in subparagraph 
(1) of this paragraph shall be paid (or may be paid in the discretion of 
the trustee) to an organization described in section 170(c) provided 
that, in the case of distributions in kind, the adjusted basis of the 
property distributed is fairly representative of the adjusted basis of 
the property available for payment on the date of payment. For example, 
the governing instrument may provide that a portion of the trust assets 
may be distributed currently, or upon the death of one or more 
recipients, to an organization described in section 170(c).
    (5) Period of payment of unitrust amount--(i) General rules. The 
period for which an amount described in subparagraph (1) of this 
paragraph is payable begins with the first year of the charitable 
remainder trust and continues either for the life or lives of a named 
individual or individuals or for a term of years not to exceed 20 years. 
Only an individual or an organization described in section 170(c) may 
receive an amount for the life of an individual. If an individual 
receives an amount for life, it must be solely for his life. Payment of 
the amount described in subparagraph (1) of this paragraph may terminate 
with the regular payment next preceding the termination of the period 
described in this subparagraph. The fact that the recipient may not 
receive such last payment shall not be taken into account for purposes 
of determining the present value of the remainder interest. In the case 
of an amount payable for a term of years, the length of the term of 
years shall be ascertainable with certainty at the time of the creation 
of the trust, except that the term may be terminated by the death of the 
recipient or by the grantor's exercise by will of a retained power to 
revoke or terminate the interest of any recipient other than an 
organization described in section 170(c). In any event, the period may 
not extend beyond either the life or lives of a named individual or 
individuals or a term of years not to exceed 20 years. For example, the 
governing instrument may not provide for the payment of a unitrust 
amount to A for his life and then to B for a term of years because it is 
possible for the period to last longer than either the lives of 
recipients in being at the creation of the trust or a term of years not 
to exceed 20 years. On the other hand, the governing instrument may 
provide for the payment of a unitrust amount to A for his life and then 
to B for his life or a term of years (not to exceed 20 years), whichever 
is shorter (but not longer), if both A and B are in being at the 
creation of the trust because it is not possible for the period to last 
longer than the lives of recipients in being at the creation of the 
trust.
    (ii) Relationship to 5 percent requirement. The 5 percent 
requirement provided in subparagraph (2) of this paragraph must be met 
until the termination of all of the payments described in subparagraph 
(1) of this paragraph. For example, the following provisions would 
satisfy the above rules:
    (a) A fixed percentage of at least 5 percent to A and B for their 
joint lives and then to the survivor for his life;
    (b) A fixed percentage of at least 5 percent to A for life or for a 
term of years not longer than 20 years, whichever is longer (or 
shorter);
    (c) A fixed percentage of at least 5 percent to A for life or for a 
term of years not longer than 20 years and then to B for life (provided 
B was living at the creation of the trust);
    (d) A fixed percentage to A for his life and concurrently a fixed 
percentage to B for his life (the percentage to each recipient to 
terminate at his death) if

[[Page 113]]

the percentage given to each individual is not less than 5 percent;
    (e) A fixed percentage to A for his life and concurrently an equal 
percentage to B for his life, and at the death of the first to die, the 
trust to distribute one-half of the then value of its assets to an 
organization described in section 170(c) if the total of the percentages 
is not less than 5 percent for the entire period described in this 
subparagraph.
    (6) Permissible remaindermen--(i) General rule. At the end of the 
period specified in subparagraph (5) of this paragraph, the entire 
corpus of the trust is required to be irrevocably transferred, in whole 
or in part, to or for the use of one or more organizations described in 
section 170(c) or retained, in whole or in part, for such use.
    (ii) Treatment of trust. If all of the trust corpus is to be 
retained for such use, the taxable year of the trust shall terminate at 
the end of the period specified in subparagraph (5) of this paragraph 
and the trust shall cease to be treated as a charitable remainder trust 
for all purposes. If all or any portion of the trust corpus is to be 
transferred to or for the use of such organization or organizations, the 
trustee shall have a reasonable time after the period specified in 
subparagraph (5) of this paragraph to complete the settlement of the 
trust. During such time, the trust shall continue to be treated as a 
charitable remainder trust for all purposes, such as section 664, 
4947(a)(2), and 4947(b)(3)(B). Upon the expiration of such period, the 
taxable year of the trust shall terminate and the trust shall cease to 
be treated as a charitable remainder trust for all purposes. If the 
trust continues in existence, it will be subject to the provisions of 
section 4947(a)(1) unless the trust is exempt from taxation under 
section 501(a). For purposes of determining whether the trust is exempt 
under section 501(a) as an organization described in section 501(c)(3), 
the trust shall be deemed to have been created at the time it ceases to 
be treated as a charitable remainder trust.
    (iii) Concurrent or successive remaindermen. Where interests in the 
corpus of the trust are given to more than one organization described in 
section 170(c) such interests may be enjoyed by them either concurrently 
or successively.
    (iv) Alternative remaindermen. The governing instrument shall 
provide that if an organization to or for the use of which the trust 
corpus is to be transferred or for the use of which the trust corpus is 
to be retained is not an organization described in section 170(c) at the 
time any amount is to be irrevocably transferred to or for the use of 
such organization, such amount shall be transferred to or for the use of 
or retained for the use of one or more alternative organizations which 
are described in section 170(c) at such time. Such alternative 
organization or organizations may be selected in any manner provided by 
the terms of the governing instrument.
    (b) Additional contributions. A trust is not a charitable remainder 
annuity trust unless its governing instrument either prohibits 
additional contributions to the trust after the initial contribution or 
provides that for the taxable year of the trust in which the additional 
contribution is made:
    (1) Where no valuation date occurs after the time of the 
contribution and during the taxable year in which the contribution is 
made, the additional property shall be valued as of the time of 
contribution; and
    (2) The amount described in paragraph (a)(1)(i)(a) of this section 
shall be computed by multiplying the fixed percentage by the sum of (i) 
the net fair market value of the trust assets (excluding the value of 
the additional property and any earned income from and any appreciation 
on such property after its contribution), and (ii) that proportion of 
the value of the additional property (that was excluded under 
subdivision (i) of this paragraph), which the number of days in the 
period which begins with the date of contribution and ends with the 
earlier of the last day of such taxable year or the last day of the 
period described in paragraph (a)(5) of this section bears to the number 
of days in the period which begins with the first day of such taxable 
year and ends with the earlier of the last day of such taxable year or 
the last day of the period described in paragraph (a)(5) of this 
section.


[[Page 114]]


For purposes of this section, all property passing to a charitable 
remainder unitrust by reason of death of the grantor shall be considered 
one contribution. The application of the preceding rules may be 
illustrated by the following examples:

    Example 1. On March 2, 1971, X makes an additional contribution of 
property to a charitable remainder unitrust. The taxable year of the 
trust is the calendar year and the regular valuation date is January 1 
of each year. For purposes of computing the required payout with respect 
to the additional contribution for the year of contribution, the 
additional contribution is valued on March 2, 1971, the time of 
contribution. The property had a value on that date of $5,000. Income 
from such property in the amount of $250 was received on December 31, 
1971. The required payout with respect to the additional contribution 
for the year of contribution is $208 (5 percent x $5,000 x 305/365). The 
income earned after the date of the contribution and after the regular 
valuation date does not enter into the computation.
    Example 2. On July 1, 1971, X makes an additional contribution of 
$10,000 to a charitable remainder unitrust. The taxable year of the 
trust is the calendar year and the regular valuation date is December 31 
of each year. The fixed percentage is 5 percent. Between July 1, 1971, 
and December 31, 1971, the additional property appreciates in value to 
$12,500 and earns $500 of income. Because the regular valuation date for 
the year of contribution occurs after the date of the additional 
contribution, the additional contribution including income earned by it 
is valued on the regular valuation date. Thus, the required payout with 
respect to the additional contribution is $325.87 (5 
percent x [$12,500+$500] x 183/365).

    (c) Calculation of the fair market value of the remainder interest 
of a charitable remainder unitrust. See Sec. 1.664-4 for rules relating 
to the calculation of the fair market value of the remainder interest of 
a charitable remainder unitrust.
    (d) Deduction for transfers to a charitable remainder unitrust. For 
rules relating to a deduction for transfers to a charitable remainder 
unitrust, see section 170, 2055, 2106, or 2522 and the regulations 
thereunder. The deduction allowed by section 170 for transfers to 
charity is limited to the fair market value of the remainder interest of 
a charitable remainder unitrusts regardless of whether an organization 
described in section 170(c) also receives a portion of the amount 
described in Sec. 1.664-3(a)(1). For a special rule relating to the 
reduction of the amount of a charitable contribution deduction with 
respect to a contribution of certain ordinary income property or capital 
gain property, see section 170(e)(1) (A) or (B)(i) and the regulations 
thereunder. For rules for postponing the time for deduction of a 
charitable contribution of a future interest in tangible personal 
property, see section 170(a)(3) and the regulations thereunder.

[T.D. 7202, 37 FR 16920, Aug. 23, 1972]



Sec. 1.664-4   Calculation of the fair market value of the remainder interest in a charitable remainder unitrust.

    (a) Rules for determining present value. For purposes of sections 
170, 2055, 2106, and 2522, the fair market value of a remainder interest 
in a charitable remainder unitrust (as described in Sec. 1.664-3) is its 
present value determined under paragraph (d) of this section. The 
present value determined under this section shall be computed on the 
basis of--
    (1) Life contingencies determined as to each life involved, from the 
values of lx set forth in Table 80CNSMT contained in Sec. 20.2031-
7(d)(6) of this chapter (Estate Tax Regulations) in the case of 
transfers for which the valuation date is after April 30, 1989, or 
column 2 of Table LN, of Sec. 20.2031-7A(d)(6) of this chapter in the 
case of transfers made after November 30, 1983, for which the valuation 
date is before May 1, 1989. See Sec. 20.2031-7A (a) through (c) of this 
chapter, whichever is applicable, for transfers for which the valuation 
date is before December 1, 1983;
    (2) Interest at the section 7520 rate in the case of transfers for 
which the valuation date is after April 30, 1989, or 10 percent in the 
case of transfers to charitable remainder unitrusts made after November 
30, 1983, for which the valuation date is before May 1, 1989. See 
Sec. 20.2031-7A (a) through (c) of this chapter, whichever is 
applicable, for transfers for which the valuation date is before 
December 1, 1983; and
    (3) The assumption that the amount described in Sec. 1.664-
3(a)(1)(i)(a) is distributed in accordance with the payout sequence 
described in the governing instrument. If the governing instrument

[[Page 115]]

does not prescribe when the distribution is made during the period for 
which the payment is made, for purposes of this section, the 
distribution is considered payable on the first day of the period for 
which the payment is made.
    (b) Actuarial Computations by the Internal Revenue Service. The 
regulations in this and in related sections provide tables of actuarial 
factors and examples that illustrate the use of the tables in 
determining the value of remainder interests in property. Section 
1.7520-1(c)(2) refers to government publications that provide additional 
tables of factors and examples of computations for more complex 
situations. If the computation requires the use of a factor that is not 
provided in this section, the Commissioner may supply the factor upon a 
request for a ruling. A request for a ruling must be accompanied by a 
recitation of the facts including the date of birth of each measuring 
life, and copies of the relevant documents. A request for a ruling must 
comply with the instructions for requesting a ruling published 
periodically in the Internal Revenue Bulletin (See 
Sec. 601.601(d)(2)(ii)(b) of this chapter) and include payment of the 
required user fee. If the Commissioner furnishes the factor, a copy of 
the letter supplying the factor should be attached to the tax return in 
which the deduction is claimed. If the Commissioner does not furnish the 
factor, the taxpayer must furnish a factor computed in accordance with 
the principles set forth in this section.
    (c) Statement supporting deduction required. Any claim for a 
deduction on any return for the value of a remainder interest in a 
charitable remainder unitrust must be supported by a full statement 
attached to the return showing the computation of the present value of 
such interest.
    (d) Valuation. The fair market value of a remainder interest in a 
charitable remainder unitrust (as described in Sec. 1.664-3) for 
transfers for which the valuation date is after April 30, 1989, is its 
present value determined under paragraph (e) of this section. The fair 
market value of a remainder interest in a charitable remainder unitrust 
(as described in Sec. 1.664-3) for transfers for which the valuation 
date is before May 1, 1989, is its present value determined under the 
following sections:

------------------------------------------------------------------------
                Valuation dates                                         
-----------------------------------------------  Applicable  regulations
               After                   Before                           
------------------------------------------------------------------------
                                      01-01-52  1.664-4A(a)             
12-31-51...........................   01-01-71  1.664-4A(b)             
12-31-70...........................   12-01-83  1.664-4A(c)             
11-30-83...........................   05-01-89  1.664-4A(d)             
------------------------------------------------------------------------

    (e) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
April 30, 1989--(1) In general. Except as otherwise provided in 
paragraph (e)(2) of this section, in the case of transfers for which the 
valuation date is after April 30, 1989, the present value of a remainder 
interest is determined under paragraphs (e)(3) through (e)(6) of this 
section, provided that the amount of the payout as of any payout date 
during any taxable year of the trust is not larger than the amount that 
the trust could distribute on such date under Sec. 1.664-3(a)(1)(v) if 
the taxable year of the trust were to end on such date. See, however, 
Sec. 1.7520-3(b) (relating to exceptions to the use of the prescribed 
tables under certain circumstances).
    (2) Transitional rules for valuation of charitable remainder 
unitrusts. (i) If the valuation date of a transfer to a charitable 
remainder unitrust is after April 30, 1989, and before June 10, 1994, a 
transferor can rely upon Notice 89-24, 1989-1 C.B. 660, or Notice 89-60, 
1989-1 C.B. 700, in valuing the transferred interest. (See 
Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (ii) For purposes of sections 2055, 2106, or 2624, if on May 1, 
1989, the decedent was mentally incompetent so that the disposition of 
the property could not be changed, and the decedent died after April 30, 
1989, without having regained competency to dispose of the decedent's 
property, or the decedent died within 90 days of the date that the 
decedent first regained competency after April 30, 1989, the present 
value of a remainder interest determined under this section is 
determined as if the valuation date with respect to the decedent's gross 
estate is either before May 1, 1989, or after April 30, 1989, at the 
option of the decedent's executor.

[[Page 116]]

    (3) Adjusted payout rate. For transfers for which the valuation date 
is after April 30, 1989, the adjusted payout rate is determined by using 
the appropriate Table F, contained in paragraph (e)(6) of this section, 
for the section 7520 interest rate applicable to the transfer. If the 
interest rate is between 4.2 and 14 percent, see paragraph (e)(6) of 
this section. If the interest rate is below 4.2 percent or greater than 
14 percent, see Sec. 1.664-4(b). The adjusted payout rate is determined 
by multiplying the fixed percentage described in Sec. 1.664-
3(a)(1)(i)(a) by the factor describing the payout sequence of the trust 
and the number of months by which the valuation date for the first full 
taxable year of the trust precedes the first payout date for such 
taxable year. If the governing instrument does not prescribe when the 
distribution or distributions shall be made during the taxable year of 
the trust, see Sec. 1.664-4(a). In the case of a trust having a payout 
sequence for which no figures have been provided by the appropriate 
table, and in the case of a trust that determines the fair market value 
of the trust assets by taking the average of valuations on more than one 
date during the taxable year, see Sec. 1.664-4(b).
    (4) Period is a term of years. If the period described in 
Sec. 1.664-3(a)(5) is a term of years, the factor that is used in 
determining the present value of the remainder interest for transfers 
for which the valuation date is after April 30, 1989, is the factor 
under the appropriate adjusted payout rate in Table D in paragraph 
(e)(6) of this section corresponding to the number of years in the 
years. If the adjusted payout rate is an amount that is between adjusted 
payout rates for which factors are provided in Table D, a linear 
interpolation must be made. The present value of the remainder interest 
is determined by multiplying the net fair market value (as of the 
appropriate valuation date) of the property placed in trust by the 
factor determined under this paragraph. For purposes of this section, 
the valuation date is, in the case of an inter vivos transfer, the date 
on which the property is transferred to the trust by the donor. However, 
if an election is made under section 7520 and Sec. 1.7520-2(b) to 
compute the present value of the charitable interest by use of the 
interest rate component for either of the 2 months preceding the month 
in which the date of transfer falls, the month so elected is the 
valuation date for purposes of determining the interest rate and 
mortality tables. In the case of a testamentary transfer under section 
2055, 2106, or 2624, the valuation date is the date of death, unless the 
alternate valuation date is elected under section 2032, in which event, 
and within the limitations set forth in section 2032 and the regulations 
thereunder, the valuation date is the alternate valuation date. If the 
decedent's estate elects the alternate valuation date under section 2032 
and also elects, under section 7520 and Sec. 1.7520-2(b), to use the 
interest rate component for one of the 2 months preceding the alternate 
valuation date, the month so elected is the valuation date for purposes 
of determining the interest rate and mortality tables. If the adjusted 
payout rate is between 4.2 and 14 percent, see paragraph (e)(6) of this 
section. If the adjusted payout rate is less than 4.2 percent or greater 
than 14 percent, see Sec. 1.664-4(b). The application of this paragraph 
may be illustrated by the following example:

    Example. D transfers $100,000 to a charitable remainder unitrust on 
January 1, 1990. The trust instrument requires that the trust pay 8 
percent of the fair market value of the trust assets as of January 1st 
for a term of 12 years to D in quarterly payments (March 31, June 30, 
September 30, and December 31). The section 7520 rate of January 1990 is 
9.6 percent. Under Table F(9.6), the appropriate adjustment factor is 
.944628 for quarterly payments payable at the end of each quarter. The 
adjusted payout rate is 7.557 (8% x .944628). Based on the remainder 
factors in Table D, the present value of the remainder interest is 
$38,950.30, computed as follows:

Factor at 7.4 percent for 12 years.........................      .397495
Factor at 7.6 percent for 12 years.........................      .387314
                                                            ------------
Difference.................................................      .010181
                                                                        


[[Page 117]]

[GRAPHIC] [TIFF OMITTED] TR10JN94.002


Factor at 7.4 percent for 12 years.........................      .397495
Less: Interpolation adjustment.............................      .007992
                                                            ------------
Interpolated factor........................................      .389503
Present value of remainder interest:                                    
  ($100,000 x .389503).....................................   $38,950.30
                                                                        

    (5) Period is the life of one individual. If the period described in 
Sec. 1.664-3(a)(5) is the life of one individual, the factor that is 
used in determining the present value of the remainder interest for 
transfers for which the valuation date is after April 30, 1989, is the 
factor in Table U(1) in paragraph (e)(6) of this section under the 
appropriate adjusted payout. For purposes of the computations described 
in this paragraph, the age of an individual is the age of that 
individual at the individual's nearest birthday. If the adjusted payout 
rate is an amount that is between adjusted payout rates for which 
factors are provided in the appropriate table, a linear interpolation 
must be made. The present value of the remainder interest is determined 
by multiplying the net fair market value (as of the valuation date as 
determined in paragraph (e)(4) of this section) of the property placed 
in trust by the factor determined under this paragraph (e)(5). If the 
adjusted payout rate is between 4.2 and 14 percent, see paragraph (e)(6) 
of this section. If the adjusted payout rate is below 4.2 percent or 
greater than 14 percent, see Sec. 1.664-4(b). The application of this 
paragraph may be illustrated by the following example:

    Example. A, who will be 45 years old on February 19, 1990, transfers 
$100,000 to a charitable remainder unitrust on January 1, 1990. The 
trust instrument requires that the trust pay to A semiannually (on June 
30 and December 31) 9 percent of the fair market value of the trust 
assets as of January 1st during A's life. The section 7520 rate for 
January 1990 is 9.6 percent. Under Table F(9.6), the appropriate 
adjustment factor is .933805 for semiannual payments payable at the end 
of the semiannual period. The adjusted payout rate is 8.404 
(9% x .933805). Based on the remainder factors in Table U(1), the 
present value of the remainder interest is $11,098.00, computed as 
follows:

Factor at 8.4 percent at age 45................................   .11106
Factor at 8.6 percent at age 45................................   .10683
                                                                --------
Difference.....................................................   .00423
                                                                        

                                                                 [GRAPHIC] [TIFF OMITTED] TR10JN94.004
                                                                 

Factor at 8.4 percent at age 45............................       .11106
Less: Interpolation adjustment.............................       .00008
                                                            ------------
Interpolated Factor........................................       .11098
Present value of remainder interest:                                    
  ($100,000 x .11098)......................................   $11,098.00
                                                                        

    (6) Actuarial tables for transfers for which the valuation date is 
after April 30, 1989. For transfers for which the valuation date is 
after April 30, 1989, the present value of a charitable remainder 
unitrust interest that is dependent on a term of years or the 
termination of a life interest is determined by using the section 7520 
rate and the tables set forth below. See, however, Sec. 1.7520-3(b) 
(relating to exceptions to the use of prescribed tables under certain 
circumstances). Many actuarial factors not contained in the following 
tables are contained in Internal Revenue Service Publication 1458, 
``Actuarial Values, Beta Volume,'' (8-89). A copy of this publication 
may be purchased from the Superintendent of Documents, United States 
Government Printing Office, Washington, DC 20402.

[[Page 118]]



               Table D.--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust              
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .958000   .956000   .954000   .952000   .950000   .948000   .946000   .944000   .942000   .940000
2...................................................   .917764   .913936   .910116   .906304   .902500   .898704   .894916   .891136   .887364   .883600
3...................................................   .879218   .873723   .868251   .862801   .857375   .851971   .846591   .841232   .835897   .830584
4...................................................   .842291   .835279   .828311   .821387   .814506   .807669   .800875   .794123   .787415   .780749
5...................................................   .806915   .798527   .790209   .781960   .773781   .765670   .757627   .749652   .741745   .733904
6...................................................   .773024   .763392   .753859   .744426   .735092   .725855   .716716   .707672   .698724   .689870
7...................................................   .740557   .729802   .719182   .708694   .698337   .688111   .678013   .668042   .658198   .648478
8...................................................   .709454   .697691   .686099   .674677   .663420   .652329   .641400   .630632   .620022   .609569
9...................................................   .679657   .666993   .654539   .642292   .630249   .618408   .606765   .595317   .584061   .572995
10..................................................   .651111   .637645   .624430   .611462   .598737   .586251   .573999   .561979   .550185   .538615
11..................................................   .623764   .609589   .595706   .582112   .568800   .555766   .543003   .530508   .518275   .506298
12..................................................   .597566   .582767   .568304   .554170   .540360   .526866   .513681   .500800   .488215   .475920
13..................................................   .572469   .557125   .542162   .527570   .513342   .499469   .485942   .472755   .459898   .447365
14..................................................   .548425   .532611   .517222   .502247   .487675   .473496   .459701   .446281   .433224   .420523
15..................................................   .525391   .509177   .493430   .478139   .463291   .448875   .434878   .421289   .408097   .395292
16..................................................   .503325   .486773   .470732   .455188   .440127   .425533   .411394   .397697   .384427   .371574
17..................................................   .482185   .465355   .449079   .433339   .418120   .403405   .389179   .375426   .362131   .349280
18..................................................   .461933   .444879   .428421   .412539   .397214   .382428   .368163   .354402   .341127   .328323
19..................................................   .442532   .425304   .408714   .392737   .377354   .362542   .348282   .334555   .321342   .308624
20..................................................   .423946   .406591   .389913   .373886   .358486   .343690   .329475   .315820   .302704   .290106
--------------------------------------------------------------------------------------------------------------------------------------------------------


               Table D.--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust              
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        6.2%      6.4%      6.6%      6.8%      7.0%      7.2%      7.4%      7.6%      7.8%      8.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .938000   .936000   .934000   .932000   .930000   .928000   .926000   .924000   .922000   .920000
2...................................................   .879844   .876096   .872356   .868624   .864900   .861184   .857476   .853776   .850084   .846400
3...................................................   .825294   .820026   .814781   .809558   .804357   .799179   .794023   .788889   .783777   .778688
4...................................................   .774125   .767544   .761005   .754508   .748052   .741638   .735265   .728933   .722643   .716393
5...................................................   .726130   .718421   .710779   .703201   .695688   .688240   .680855   .673535   .666277   .659082
6...................................................   .681110   .672442   .663867   .655383   .646990   .638687   .630472   .622346   .614307   .606355
7...................................................   .638881   .629406   .620052   .610817   .601701   .592701   .583817   .575048   .566391   .557847
8...................................................   .599270   .589124   .579129   .569282   .559582   .550027   .540615   .531344   .522213   .513219
9...................................................   .562115   .551420   .540906   .530571   .520411   .510425   .500609   .490962   .481480   .472161
10..................................................   .527264   .516129   .505206   .494492   .483982   .473674   .463564   .453649   .443925   .434388
11..................................................   .494574   .483097   .471863   .460866   .450104   .439570   .429260   .419171   .409298   .399637
12..................................................   .463910   .452179   .440720   .429527   .418596   .407921   .397495   .387314   .377373   .367666
13..................................................   .435148   .423239   .411632   .400320   .389295   .378550   .368081   .357879   .347938   .338253
14..................................................   .408169   .396152   .384465   .373098   .362044   .351295   .340843   .330680   .320799   .311193
15..................................................   .382862   .370798   .359090   .347727   .336701   .326002   .315620   .305548   .295777   .286297
16..................................................   .359125   .347067   .335390   .324082   .313132   .302529   .292264   .282326   .272706   .263394
17..................................................   .336859   .324855   .313254   .302044   .291213   .280747   .270637   .260870   .251435   .242322
18..................................................   .315974   .304064   .292579   .281505   .270828   .260533   .250610   .241044   .231823   .222936
19..................................................   .296383   .284604   .273269   .262363   .251870   .241775   .232065   .222724   .213741   .205101
20..................................................   .278008   .266389   .255233   .244522   .234239   .224367   .214892   .205797   .197069   .188693
--------------------------------------------------------------------------------------------------------------------------------------------------------


               Table D.--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust              
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .918000   .916000   .914000   .912000   .910000   .908000   .906000   .904000   .902000   .900000
2...................................................   .842724   .839056   .835396   .831744   .828100   .824464   .820836   .817216   .813604   .810000
3...................................................   .773621   .768575   .763552   .758551   .753571   .748613   .743677   .738763   .733871   .729000
4...................................................   .710184   .704015   .697886   .691798   .685750   .679741   .673772   .667842   .661951   .656100
5...................................................   .651949   .644878   .637868   .630920   .624032   .617205   .610437   .603729   .597080   .590490
6...................................................   .598489   .590708   .583012   .575399   .567869   .560422   .553056   .545771   .538566   .531441
7...................................................   .549413   .541089   .532873   .524764   .516761   .508863   .501069   .493377   .485787   .478297
8...................................................   .504361   .495637   .487046   .478585   .470253   .462048   .453968   .446013   .438180   .430467

[[Page 119]]

                                                                                                                                                        
9...................................................   .463003   .454004   .445160   .436469   .427930   .419539   .411295   .403196   .395238   .387420
10..................................................   .425037   .415867   .406876   .398060   .389416   .380942   .372634   .364489   .356505   .348678
11..................................................   .390184   .380934   .371885   .363031   .354369   .345895   .337606   .329498   .321567   .313811
12..................................................   .358189   .348936   .339902   .331084   .322475   .314073   .305871   .297866   .290054   .282430
13..................................................   .328817   .319625   .310671   .301949   .293453   .285178   .277119   .269271   .261628   .254187
14..................................................   .301854   .292777   .283953   .275377   .267042   .258942   .251070   .243421   .235989   .228768
15..................................................   .277102   .268184   .259533   .251144   .243008   .235119   .227469   .220053   .212862   .205891
16..................................................   .254380   .245656   .237213   .229043   .221137   .213488   .206087   .198928   .192001   .185302
17..................................................   .233521   .225021   .216813   .208887   .201235   .193847   .186715   .179830   .173185   .166772
18..................................................   .214372   .206119   .198167   .190505   .183124   .176013   .169164   .162567   .156213   .150095
19..................................................   .196794   .188805   .181125   .173741   .166643   .159820   .153262   .146960   .140904   .135085
20..................................................   .180657   .172946   .165548   .158452   .151645   .145117   .138856   .132852   .127096   .121577
--------------------------------------------------------------------------------------------------------------------------------------------------------


               Table D.--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust              
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        10.2%     10.4%     10.6%     10.8%     11.0%     11.2%     11.4%     11.6%     11.8%     12.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .898000   .896000   .894000   .892000   .890000   .888000   .886000   .884000   .882000   .880000
2...................................................   .806404   .802816   .799236   .795664   .792100   .788544   .784996   .781456   .777924   .774400
3...................................................   .724151   .719323   .714517   .709732   .704969   .700227   .695506   .690807   .686129   .681472
4...................................................   .650287   .644514   .638778   .633081   .627422   .621802   .616219   .610673   .605166   .599695
5...................................................   .583958   .577484   .571068   .564708   .558406   .552160   .545970   .539835   .533756   .527732
6...................................................   .524394   .517426   .510535   .503720   .496981   .490318   .483729   .477214   .470773   .464404
7...................................................   .470906   .463613   .456418   .449318   .442313   .435402   .428584   .421858   .415222   .408676
8...................................................   .422874   .415398   .408038   .400792   .393659   .386637   .379726   .372922   .366226   .359635
9...................................................   .379741   .372196   .364786   .357506   .350356   .343334   .336437   .329663   .323011   .316478
10..................................................   .341007   .333488   .326118   .318896   .311817   .304881   .298083   .291422   .284896   .278501
11..................................................   .306224   .298805   .291550   .284455   .277517   .270734   .264102   .257617   .251278   .245081
12..................................................   .274989   .267729   .260645   .253734   .246990   .240412   .233994   .227734   .221627   .215671
13..................................................   .246941   .239886   .233017   .226331   .219821   .213486   .207319   .201317   .195475   .189791
14..................................................   .221753   .214937   .208317   .201887   .195641   .189575   .183684   .177964   .172409   .167016
15..................................................   .199134   .192584   .186236   .180083   .174121   .168343   .162744   .157320   .152065   .146974
16..................................................   .178822   .172555   .166495   .160634   .154967   .149488   .144191   .139071   .134121   .129337
17..................................................   .160582   .154609   .148846   .143286   .137921   .132746   .127754   .122939   .118295   .113817
18..................................................   .144203   .138530   .133069   .127811   .122750   .117878   .113190   .108678   .104336   .100159
19..................................................   .129494   .124123   .118963   .114007   .109247   .104676   .100286   .096071   .092024   .088140
20..................................................   .116286   .111214   .106353   .101694   .097230   .092952   .088853   .084927   .081166   .077563
--------------------------------------------------------------------------------------------------------------------------------------------------------


               Table D.--Showing the Present Worth of a Remainder Interest Postponed for a Term Certain in a Charitable Remainder Unitrust              
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                        Years                        ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
1...................................................   .878000   .876000   .874000   .872000   .870000   .868000   .866000   .864000   .862000   .860000
2...................................................   .770884   .767376   .763876   .760384   .756900   .753424   .749956   .746496   .743044   .739600
3...................................................   .676836   .672221   .667628   .663055   .658503   .653972   .649462   .644973   .640504   .636056
4...................................................   .594262   .588866   .583507   .578184   .572898   .567648   .562434   .557256   .552114   .547008
5...................................................   .521762   .515847   .509985   .504176   .498421   .492718   .487068   .481469   .475923   .470427
6...................................................   .458107   .451882   .445727   .439642   .433626   .427679   .421801   .415990   .410245   .404567
7...................................................   .402218   .395848   .389565   .383368   .377255   .371226   .365279   .359415   .353631   .347928
8...................................................   .353147   .346763   .340480   .334297   .328212   .322224   .316332   .310535   .304830   .299218
9...................................................   .310063   .303764   .297579   .291507   .285544   .279690   .273944   .268302   .262764   .257327
10..................................................   .272236   .266098   .260084   .254194   .248423   .242771   .237235   .231813   .226502   .221302
11..................................................   .239023   .233102   .227314   .221657   .216128   .210725   .205446   .200286   .195245   .190319
12..................................................   .209862   .204197   .198672   .193285   .188032   .182910   .177916   .173047   .168301   .163675
13..................................................   .184259   .178877   .173640   .168544   .163588   .158766   .154075   .149513   .145076   .140760
14..................................................   .161779   .156696   .151761   .146971   .142321   .137809   .133429   .129179   .125055   .121054
15..................................................   .142042   .137266   .132639   .128158   .123819   .119618   .115550   .111611   .107798   .104106
16..................................................   .124713   .120245   .115927   .111754   .107723   .103828   .100066   .096432   .092922   .089531

[[Page 120]]

                                                                                                                                                        
17..................................................   .109498   .105334   .101320   .097450   .093719   .090123   .086657   .083317   .080098   .076997
18..................................................   .096139   .092273   .088554   .084976   .081535   .078227   .075045   .071986   .069045   .066217
19..................................................   .084410   .080831   .077396   .074099   .070936   .067901   .064989   .062196   .059517   .056947
20..................................................   .074112   .070808   .067644   .064614   .061714   .058938   .056280   .053737   .051303   .048974
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 121]]


             Table F(4.2).--With Interest at 4.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .989820                   .984755                  .981389   
 1......................                     2                   .996577                   .986432                   .981385                  .978030   
 2......................                     3                   .993166                   .983056                   .978026                            
 3......................                     4                   .989767                   .979691                   .974679                            
 4......................                     5                   .986380                   .976338                                                      
 5......................                     6                   .983004                   .972996                                                      
 6......................                     7                   .979639                   .969666                                                      
 7......................                     8                   .976286                                                                                
 8......................                     9                   .972945                                                                                
 9......................                    10                   .969615                                                                                
10......................                    11                   .966296                                                                                
11......................                    12                   .962989                                                                                
12......................  ........................               .959693                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(4.4).--With Interest at 4.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .989350                   .984054                  .980533   
 1......................                     2                   .996418                   .985806                   .980529                  .977021   
 2......................                     3                   .992849                   .982275                   .977017                            
 3......................                     4                   .989293                   .978757                   .973517                            
 4......................                     5                   .985749                   .975251                                                      
 5......................                     6                   .982219                   .971758                                                      
 6......................                     7                   .978700                   .968277                                                      
 7......................                     8                   .975195                                                                                
 8......................                     9                   .971702                                                                                
 9......................                    10                   .968221                                                                                
10......................                    11                   .964753                                                                                
11......................                    12                   .961298                                                                                
12......................  ........................               .957854                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(4.6).--With Interest at 4.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .988882                   .983354                  .979680   
 1......................                     2                   .996259                   .985183                   .979676                  .976015   
 2......................                     3                   .992532                   .981498                   .976011                            
 3......................                     4                   .988820                   .977826                   .972360                            
 4......................                     5                   .985121                   .974168                                                      
 5......................                     6                   .981436                   .970524                                                      
 6......................                     7                   .977764                   .966894                                                      
 7......................                     8                   .974107                                                                                
 8......................                     9                   .970463                                                                                
 9......................                    10                   .966832                                                                                
10......................                    11                   .963216                                                                                
11......................                    12                   .959613                                                                                

[[Page 122]]

                                                                                                                                                        
12......................  ........................               .956023                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(4.8).--With Interest at 4.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .988415                   .982657                  .978830   
 1......................                     2                   .996101                   .984561                   .978825                  .975013   
 2......................                     3                   .992217                   .980722                   .975008                            
 3......................                     4                   .988348                   .976898                   .971206                            
 4......................                     5                   .984494                   .973089                                                      
 5......................                     6                   .980655                   .969294                                                      
 6......................                     7                   .976831                   .965515                                                      
 7......................                     8                   .973022                                                                                
 8......................                     9                   .969228                                                                                
 9......................                    10                   .965448                                                                                
10......................                    11                   .961684                                                                                
11......................                    12                   .957934                                                                                
12......................  ........................               .954198                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(5.0).--With Interest at 5.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .987950                   .981961                  .977982   
 1......................                     2                   .995942                   .983941                   .977977                  .974014   
 2......................                     3                   .991901                   .979949                   .974009                            
 3......................                     4                   .987877                   .975973                   .970057                            
 4......................                     5                   .983868                   .972013                                                      
 5......................                     6                   .979876                   .968069                                                      
 6......................                     7                   .975900                   .964141                                                      
 7......................                     8                   .971940                                                                                
 8......................                     9                   .967997                                                                                
 9......................                    10                   .964069                                                                                
10......................                    11                   .960157                                                                                
11......................                    12                   .956261                                                                                
12......................  ........................               .952381                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 123]]


             Table F(5.2).--With Interest at 5.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .987486                   .981268                  .977137   
 1......................                     2                   .995784                   .983323                   .977132                  .973018   
 2......................                     3                   .991587                   .979178                   .973012                            
 3......................                     4                   .987407                   .975050                   .968911                            
 4......................                     5                   .983244                   .970940                                                      
 5......................                     6                   .979099                   .966847                                                      
 6......................                     7                   .974972                   .962771                                                      
 7......................                     8                   .970862                                                                                
 8......................                     9                   .966769                                                                                
 9......................                    10                   .962694                                                                                
10......................                    11                   .958636                                                                                
11......................                    12                   .954594                                                                                
12......................  ........................               .950570                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(5.4).--With Interest at 5.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .987023                   .980577                  .976295   
 1......................                     2                   .995627                   .982707                   .976289                  .972026   
 2......................                     3                   .991273                   .978409                   .972019                            
 3......................                     4                   .986938                   .974131                   .967769                            
 4......................                     5                   .982622                   .969871                                                      
 5......................                     6                   .978325                   .965629                                                      
 6......................                     7                   .974047                   .961407                                                      
 7......................                     8                   .969787                                                                                
 8......................                     9                   .965546                                                                                
 9......................                    10                   .961323                                                                                
10......................                    11                   .957119                                                                                
11......................                    12                   .952934                                                                                
12......................  ........................               .948767                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(5.6).--With Interest at 5.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .986562                   .979888                  .975455   
 1......................                     2                   .995470                   .982092                   .975449                  .971036   
 2......................                     3                   .990960                   .977643                   .971029                            
 3......................                     4                   .986470                   .973214                   .966630                            
 4......................                     5                   .982001                   .968805                                                      
 5......................                     6                   .977552                   .964416                                                      
 6......................                     7                   .973124                   .960047                                                      
 7......................                     8                   .968715                                                                                
 8......................                     9                   .964326                                                                                
 9......................                    10                   .959958                                                                                
10......................                    11                   .955609                                                                                
11......................                    12                   .951279                                                                                
12......................  ........................               .946970                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 124]]


             Table F(5.8).--With Interest at 5.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .986102                   .979201                  .974618   
 1......................                     2                   .995313                   .981480                   .974611                  .970050   
 2......................                     3                   .990647                   .976879                   .970043                            
 3......................                     4                   .986004                   .972300                   .965496                            
 4......................                     5                   .981382                   .967743                                                      
 5......................                     6                   .976782                   .963206                                                      
 6......................                     7                   .972203                   .958692                                                      
 7......................                     8                   .967646                                                                                
 8......................                     9                   .963111                                                                                
 9......................                    10                   .958596                                                                                
10......................                    11                   .954103                                                                                
11......................                    12                   .949631                                                                                
12......................  ........................               .945180                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(6.0).--With Interest at 6.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .985643                   .978516                  .973784   
 1......................                     2                   .995156                   .980869                   .973776                  .969067   
 2......................                     3                   .990336                   .976117                   .969059                            
 3......................                     4                   .985538                   .971389                   .964365                            
 4......................                     5                   .980764                   .966684                                                      
 5......................                     6                   .976014                   .962001                                                      
 6......................                     7                   .971286                   .957341                                                      
 7......................                     8                   .966581                                                                                
 8......................                     9                   .961899                                                                                
 9......................                    10                   .957239                                                                                
10......................                    11                   .952603                                                                                
11......................                    12                   .947988                                                                                
12......................  ........................               .943396                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(6.2).--With Interest at 6.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .985185                   .977833                  .972952   
 1......................                     2                   .995000                   .980259                   .972944                  .968087   
 2......................                     3                   .990024                   .975358                   .968079                            
 3......................                     4                   .985074                   .970481                   .963238                            
 4......................                     5                   .980148                   .965628                                                      
 5......................                     6                   .975247                   .960799                                                      
 6......................                     7                   .970371                   .955995                                                      
 7......................                     8                   .965519                                                                                
 8......................                     9                   .960691                                                                                
 9......................                    10                   .955887                                                                                
10......................                    11                   .951107                                                                                
11......................                    12                   .946352                                                                                

[[Page 125]]

                                                                                                                                                        
12......................  ........................               .941620                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(6.4).--With Interest at 6.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .984729                   .977152                  .972122   
 1......................                     2                   .994844                   .979652                   .972114                  .967110   
 2......................                     3                   .989714                   .974600                   .967101                            
 3......................                     4                   .984611                   .969575                   .962115                            
 4......................                     5                   .979534                   .964576                                                      
 5......................                     6                   .974483                   .959602                                                      
 6......................                     7                   .969458                   .954654                                                      
 7......................                     8                   .964460                                                                                
 8......................                     9                   .959487                                                                                
 9......................                    10                   .954539                                                                                
10......................                    11                   .949617                                                                                
11......................                    12                   .944721                                                                                
12......................  ........................               .939850                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(6.6).--With Interest at 6.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .984274                   .976473                  .971295   
 1......................                     2                   .994688                   .979046                   .971286                  .966136   
 2......................                     3                   .989404                   .973845                   .966127                            
 3......................                     4                   .984149                   .968672                   .960995                            
 4......................                     5                   .978921                   .963527                                                      
 5......................                     6                   .973721                   .958408                                                      
 6......................                     7                   .968549                   .953317                                                      
 7......................                     8                   .963404                                                                                
 8......................                     9                   .958286                                                                                
 9......................                    10                   .953196                                                                                
10......................                    11                   .948132                                                                                
11......................                    12                   .943096                                                                                
12......................  ........................               .938086                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 126]]


             Table F(6.8).--With Interest at 6.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .983821                   .975796                  .970471   
 1......................                     2                   .994533                   .978442                   .970461                  .965165   
 2......................                     3                   .989095                   .973092                   .965156                            
 3......................                     4                   .983688                   .967772                   .959879                            
 4......................                     5                   .978309                   .962481                                                      
 5......................                     6                   .972961                   .957219                                                      
 6......................                     7                   .967641                   .951985                                                      
 7......................                     8                   .962351                                                                                
 8......................                     9                   .957089                                                                                
 9......................                    10                   .951857                                                                                
10......................                    11                   .946653                                                                                
11......................                    12                   .941477                                                                                
12......................  ........................               .936330                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(7.0).--With Interest at 7.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .983368                   .975122                  .969649   
 1......................                     2                   .994378                   .977839                   .969639                  .964198   
 2......................                     3                   .988787                   .972342                   .964187                            
 3......................                     4                   .983228                   .966875                   .958766                            
 4......................                     5                   .977700                   .961439                                                      
 5......................                     6                   .972203                   .956033                                                      
 6......................                     7                   .966736                   .950658                                                      
 7......................                     8                   .961301                                                                                
 8......................                     9                   .955896                                                                                
 9......................                    10                   .950522                                                                                
10......................                    11                   .945178                                                                                
11......................                    12                   .939864                                                                                
12......................  ........................               .934579                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(7.2).--With Interest at 7.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .982917                   .974449                  .968830   
 1......................                     2                   .994223                   .977239                   .968819                  .963233   
 2......................                     3                   .988479                   .971593                   .963222                            
 3......................                     4                   .982769                   .965980                   .957658                            
 4......................                     5                   .977091                   .960400                                                      
 5......................                     6                   .971446                   .954851                                                      
 6......................                     7                   .965834                   .949335                                                      
 7......................                     8                   .960255                                                                                
 8......................                     9                   .954707                                                                                
 9......................                    10                   .949192                                                                                
10......................                    11                   .943708                                                                                
11......................                    12                   .938256                                                                                

[[Page 127]]

                                                                                                                                                        
12......................  ........................               .932836                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(7.4).--With Interest at 7.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .982467                   .973778                  .968013   
 1......................                     2                   .994068                   .976640                   .968002                  .962271   
 2......................                     3                   .988172                   .970847                   .962260                            
 3......................                     4                   .982311                   .965088                   .956552                            
 4......................                     5                   .976484                   .959364                                                      
 5......................                     6                   .970692                   .953673                                                      
 6......................                     7                   .964935                   .948017                                                      
 7......................                     8                   .959211                                                                                
 8......................                     9                   .953521                                                                                
 9......................                    10                   .947866                                                                                
10......................                    11                   .942243                                                                                
11......................                    12                   .936654                                                                                
12......................  ........................               .931099                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(7.6).--With Interest at 7.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .982019                   .973109                  .967199   
 1......................                     2                   .993914                   .976042                   .967187                  .961313   
 2......................                     3                   .987866                   .970103                   .961301                            
 3......................                     4                   .981854                   .964199                   .955451                            
 4......................                     5                   .975879                   .958331                                                      
 5......................                     6                   .969940                   .952499                                                      
 6......................                     7                   .964037                   .946703                                                      
 7......................                     8                   .958171                                                                                
 8......................                     9                   .952340                                                                                
 9......................                    10                   .946544                                                                                
10......................                    11                   .940784                                                                                
11......................                    12                   .935058                                                                                
12......................  ........................               .929368                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 128]]


             Table F(7.8).--With Interest at 7.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                 1.0000000                   .981571                   .972442                  .966387   
 1......................                     2                   .993761                   .975447                   .966374                  .960357   
 2......................                     3                   .987560                   .969361                   .960345                            
 3......................                     4                   .981398                   .963312                   .954353                            
 4......................                     5                   .975275                   .957302                                                      
 5......................                     6                   .969190                   .951329                                                      
 6......................                     7                   .963143                   .945393                                                      
 7......................                     8                   .957133                                                                                
 8......................                     9                   .951161                                                                                
 9......................                    10                   .945227                                                                                
10......................                    11                   .939329                                                                                
11......................                    12                   .933468                                                                                
12......................  ........................               .927644                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(8.0).--With Interest at 8.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2  Factors for payout at the end of each period                          
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .981125                   .971777                  .965578   
 1......................                     2                   .993607                   .974853                   .965564                  .959405   
 2......................                     3                   .987255                   .968621                   .959392                            
 3......................                     4                    980944                   .962429                   .953258                            
 4......................                     5                   .974673                   .956276                                                      
 5......................                     6                   .968442                   .950162                                                      
 6......................                     7                   .962250                   .944088                                                      
 7......................                     8                   .956099                                                                                
 8......................                     9                   .949987                                                                                
 9......................                    10                   .943913                                                                                
10......................                    11                   .937879                                                                                
11......................                    12                   .931883                                                                                
12......................  ........................               .925926                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(8.2).--With Interest at 8.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2  Factors for payout at the end of each period                          
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .980680                   .971114                  .964771   
 1......................                     2                   .993454                   .974261                   .964757                  .958455   
 2......................                     3                   .986951                   .967883                   .958441                            
 3......................                     4                   .980490                   .961547                   .952167                            
 4......................                     5                   .974072                   .955253                                                      
 5......................                     6                   .967695                   .949000                                                      
 6......................                     7                   .961361                   .942788                                                      
 7......................                     8                   .955068                                                                                
 8......................                     9                   .948816                                                                                
 9......................                    10                   .942605                                                                                
10......................                    11                   .936434                                                                                
11......................                    12                   .930304                                                                                
12......................  ........................               .924214                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 129]]


             Table F(8.2).--With Interest at 8.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2  Factors for payout at the end of each period                          
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .980237                   .970453                  .963966   
 1......................                     2                   .993301                   .973670                   .963952                  .957509   
 2......................                     3                   .986647                   .967148                   .957494                            
 3......................                     4                   .980037                   .960669                   .951080                            
 4......................                     5                   .973472                   .954233                                                      
 5......................                     6                   .966951                   .947841                                                      
 6......................                     7                   .960473                   .941491                                                      
 7......................                     8                   .954039                                                                                
 8......................                     9                   .947648                                                                                
 9......................                    10                   .941300                                                                                
10......................                    11                   .934994                                                                                
11......................                    12                   .928731                                                                                
12......................  ........................               .922509                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(8.6).--With Interest at 8.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .979794                   .969794                  .963164   
 1......................                     2                   .993148                   .973081                   .963149                  .956565   
 2......................                     3                   .986344                   .966414                   .956550                            
 3......................                     4                   .979586                   .959793                   .949996                            
 4......................                     5                   .972874                   .953217                                                      
 5......................                     6                   .966209                   .946686                                                      
 6......................                     7                   .959589                   .940199                                                      
 7......................                     8                   .953014                                                                                
 8......................                     9                   .946484                                                                                
 9......................                    10                   .940000                                                                                
10......................                    11                   .933559                                                                                
11......................                    12                   .927163                                                                                
12......................  ........................               .920810                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(8.8).--WITH INTEREST AT 8.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .979353                   .969136                  .962364   
 1......................                     2                   .992996                   .972494                   .962349                  .955624   
 2......................                     3                   .986041                   .965683                   .955609                            
 3......................                     4                   .979135                   .958919                   .948916                            
 4......................                     5                   .972278                   .952203                                                      
 5......................                     6                   .965468                   .945534                                                      
 6......................                     7                   .958706                   .938912                                                      
 7......................                     8                   .951992                                                                                
 8......................                     9                   .945324                                                                                
 9......................                    10                   .938703                                                                                
10......................                    11                   .932129                                                                                
11......................                    12                   .925600                                                                                
12......................  ........................               .919118                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 130]]


             Table F(9.0).--With Interest at 9.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .978913                   .968481                  .961567   
 1......................                     2                   .992844                   .971908                   .961551                  .954686   
 2......................                     3                   .985740                   .964954                   .954670                            
 3......................                     4                   .978686                   .958049                   .947839                            
 4......................                     5                   .971683                   .951193                                                      
 5......................                     6                   .964730                   .944387                                                      
 6......................                     7                   .957826                   .937629                                                      
 7......................                     8                   .950972                                                                                
 8......................                     9                   .944167                                                                                
 9......................                    10                   .937411                                                                                
10......................                    11                   .930703                                                                                
11......................                    12                   .924043                                                                                
12......................  ........................               .917431                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(9.2).--With Interest at 9.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .978474                   .967827                  .960772   
 1......................                     2                   .992693                   .971324                   .960755                  .953752   
 2......................                     3                   .985439                   .964226                   .953734                            
 3......................                     4                   .978238                   .957180                   .946765                            
 4......................                     5                   .971089                   .950186                                                      
 5......................                     6                   .963993                   .943242                                                      
 6......................                     7                   .956949                   .936350                                                      
 7......................                     8                   .949956                                                                                
 8......................                     9                   .943014                                                                                
 9......................                    10                   .936123                                                                                
10......................                    11                   .929283                                                                                
11......................                    12                   .922492                                                                                
12......................  ........................               .915751                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F (9.4).--With Interest at 9.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .978037                   .967176                  .959980   
 1......................                     2                   .992541                   .970742                   .959962                  .952820   
 2......................                     3                   .985138                   .963501                   .952802                            
 3......................                     4                   .977790                   .956315                   .945695                            
 4......................                     5                   .970497                   .949182                                                      
 5......................                     6                   .963258                   .942102                                                      
 6......................                     7                   .956074                   .935075                                                      
 7......................                     8                   .948942                                                                                
 8......................                     9                   .941865                                                                                
 9......................                    10                   .934839                                                                                
10......................                    11                   .927867                                                                                
11......................                    12                   .920946                                                                                
12......................  ........................               .914077                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 131]]


             Table F(9.6).--With Interest at 9.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .977600                   .966526                  .959190   
 1......................                     2                   .992390                   .970161                   .959171                  .951890   
 2......................                     3                   .984838                   .962778                   .951872                            
 3......................                     4                   .977344                   .955452                   .944628                            
 4......................                     5                   .969906                   .948181                                                      
 5......................                     6                   .962526                   .940965                                                      
 6......................                     7                   .955201                   .933805                                                      
 7......................                     8                   .947932                                                                                
 8......................                     9                   .940718                                                                                
 9......................                    10                   .933560                                                                                
10......................                    11                   .926455                                                                                
11......................                    12                   .919405                                                                                
12......................  ........................               .912409                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


             Table F(9.8).--With Interest at 9.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations            
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .977165                   .965878                  .958402   
 1......................                     2                   .992239                   .969582                   .958382                  .950964   
 2......................                     3                   .984539                   .962057                   .950945                            
 3......................                     4                   .976898                   .954591                   .943565                            
 4......................                     5                   .969317                   .947183                                                      
 5......................                     6                   .961795                   .939832                                                      
 6......................                     7                   .954331                   .932539                                                      
 7......................                     8                   .946924                                                                                
 8......................                     9                   .939576                                                                                
 9......................                    10                   .932284                                                                                
10......................                    11                   .925049                                                                                
11......................                    12                   .917870                                                                                
12......................  ........................               .910747                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(10.0).--With Interest at 10.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .976731                   .965232                  .957616   
 1......................                     2                   .992089                   .969004                   .957596                  .950041   
 2......................                     3                   .984240                   .961338                   .950021                            
 3......................                     4                   .976454                   .953733                   .942505                            
 4......................                     5                   .968729                   .946188                                                      
 5......................                     6                   .961066                   .938703                                                      
 6......................                     7                   .953463                   .931277                                                      
 7......................                     8                   .945920                                                                                
 8......................                     9                   .938436                                                                                
 9......................                    10                   .931012                                                                                
10......................                    11                   .923647                                                                                
11......................                    12                   .916340                                                                                
12......................  ........................               .909091                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 132]]


            Table F(10.2).--With Interest at 10.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .976298                   .964588                  .956833   
 1......................                     2                   .991939                   .968428                   .956812                  .949120   
 2......................                     3                   .983943                   .960622                   .949099                            
 3......................                     4                   .976011                   .952878                   .941448                            
 4......................                     5                   .968143                   .945196                                                      
 5......................                     6                   .960338                   .937577                                                      
 6......................                     7                   .952597                   .930019                                                      
 7......................                     8                   .944918                                                                                
 8......................                     9                   .937301                                                                                
 9......................                    10                   .929745                                                                                
10......................                    11                   .922250                                                                                
11......................                    12                   .914816                                                                                
12......................  ........................               .907441                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(10.4).--With Interest at 10.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .975867                   .963946                  .956052   
 1......................                     2                   .991789                   .967854                   .956031                  .948202   
 2......................                     3                   .983645                   .959907                   .948181                            
 3......................                     4                   .975568                   .952025                   .940395                            
 4......................                     5                   .967558                   .944208                                                      
 5......................                     6                   .959613                   .936455                                                      
 6......................                     7                   .951734                   .928765                                                      
 7......................                     8                   .943919                                                                                
 8......................                     9                   .936168                                                                                
 9......................                    10                   .928481                                                                                
10......................                    11                   .920858                                                                                
11......................                    12                   .913296                                                                                
12......................  ........................               .905797                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(10.6).--With Interest at 10.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .975436                   .963305                  .955274   
 1......................                     2                   .991639                   .967281                   .955252                  .947287   
 2......................                     3                   .983349                   .959194                   .947265                            
 3......................                     4                   .975127                   .951174                   .939345                            
 4......................                     5                   .966974                   .943222                                                      
 5......................                     6                   .958890                   .935336                                                      
 6......................                     7                   .950873                   .927516                                                      
 7......................                     8                   .942923                                                                                
 8......................                     9                   .935039                                                                                
 9......................                    10                   .927222                                                                                
10......................                    11                   .919470                                                                                
11......................                    12                   .911782                                                                                
12......................  ........................               .904159                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 133]]


            Table F(10.8).--With Interest at 10.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .975007                   .962667                  .954498   
 1......................                     2                   .991490                   .966710                   .954475                  .946375   
 2......................                     3                   .983052                   .958483                   .946352                            
 3......................                     4                   .974687                   .950327                   .938299                            
 4......................                     5                   .966392                   .942239                                                      
 5......................                     6                   .958168                   .934221                                                      
 6......................                     7                   .950014                   .926271                                                      
 7......................                     8                   .941930                                                                                
 8......................                     9                   .933914                                                                                
 9......................                    10                   .925966                                                                                
10......................                    11                   .918086                                                                                
11......................                    12                   .910273                                                                                
12......................  ........................               .902527                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(11.0).--With Interest at 11.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .974579                   .962030                  .953724   
 1......................                     2                   .991341                   .966140                   .953700                  .945466   
 2......................                     3                   .982757                   .957774                   .945442                            
 3......................                     4                   .974247                   .949481                   .937255                            
 4......................                     5                   .965811                   .941260                                                      
 5......................                     6                   .957449                   .933109                                                      
 6......................                     7                   .949158                   .925029                                                      
 7......................                     8                   .940939                                                                                
 8......................                     9                   .932792                                                                                
 9......................                    10                   .924715                                                                                
10......................                    11                   .916708                                                                                
11......................                    12                   .908770                                                                                
12......................  ........................               .900901                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(11.2).--With Interest at 11.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .974152                   .961395                  .952952   
 1......................                     2                   .991192                   .965572                   .952927                  .944559   
 2......................                     3                   .982462                   .957068                   .944534                            
 3......................                     4                   .973809                   .948638                   .936215                            
 4......................                     5                   .965232                   .940283                                                      
 5......................                     6                   .956731                   .932001                                                      
 6......................                     7                   .948304                   .923792                                                      
 7......................                     8                   .939952                                                                                
 8......................                     9                   .931673                                                                                
 9......................                    10                   .923467                                                                                
10......................                    11                   .915333                                                                                
11......................                    12                   .907272                                                                                
12......................  ........................               .899281                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 134]]


            Table F(11.4).--With Interest at 11.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .973726                   .960762                  .952183   
 1......................                     2                   .991044                   .965005                   .952157                  .943655   
 2......................                     3                   .982168                   .956363                   .943630                            
 3......................                     4                   .973372                   .947798                   .935178                            
 4......................                     5                   .964654                   .939309                                                      
 5......................                     6                   .956015                   .930896                                                      
 6......................                     7                   .947452                   .922559                                                      
 7......................                     8                   .938967                                                                                
 8......................                     9                   .930557                                                                                
 9......................                    10                   .922223                                                                                
10......................                    11                   .913964                                                                                
11......................                    12                   .905778                                                                                
12......................  ........................               .897666                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(11.6).--With Interest at 11.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .973302                   .960130                  .951416   
 1......................                     2                   .990896                   .964440                   .951389                  .942754   
 2......................                     3                   .981874                   .955660                   .942728                            
 3......................                     4                   .972935                   .946959                   .934145                            
 4......................                     5                   .964077                   .938338                                                      
 5......................                     6                   .955300                   .929795                                                      
 6......................                     7                   .946603                   .921330                                                      
 7......................                     8                   .937985                                                                                
 8......................                     9                   .929445                                                                                
 9......................                    10                   .920984                                                                                
10......................                    11                   .912599                                                                                
11......................                    12                   .904290                                                                                
12......................  ........................               .896057                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(11.8).--With Interest at 11.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period          Seminannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .972878                   .959501                  .950651   
 1......................                     2                   .990748                   .963877                   .950624                  .941855   
 2......................                     3                   .981582                   .954959                   .941828                            
 3......................                     4                   .972500                   .946124                   .933114                            
 4......................                     5                   .963502                   .937370                                                      
 5......................                     6                   .954588                   .928698                                                      
 6......................                     7                   .945756                   .920105                                                      
 7......................                     8                   .937006                                                                                
 8......................                     9                   .928337                                                                                
 9......................                    10                   .919748                                                                                
10......................                    11                   .911238                                                                                
11......................                    12                   .902807                                                                                
12......................  ........................               .894454                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 135]]


            Table F(12.0).--With Interest at 12.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period          Seminannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .972456                   .958873                  .949888   
 1......................                     2                   .990600                   .963315                   .949860                  .940960   
 2......................                     3                   .981289                   .954260                   .940932                            
 3......................                     4                   .972065                   .945290                   .932087                            
 4......................                     5                   .962928                   .936405                                                      
 5......................                     6                   .953877                   .927603                                                      
 6......................                     7                   .944911                   .918884                                                      
 7......................                     8                   .936029                                                                                
 8......................                     9                   .927231                                                                                
 9......................                    10                   .918515                                                                                
10......................                    11                   .909882                                                                                
11......................                    12                   .901329                                                                                
12......................  ........................               .892857                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(12.2).--With Interest at 12.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .972034                   .958247                  .949128   
 1......................                     2                   .990453                   .962754                   .949099                  .940067   
 2......................                     3                   .980997                   .953563                   .940038                            
 3......................                     4                   .971632                   .944460                   .931063                            
 4......................                     5                   .962356                   .935443                                                      
 5......................                     6                   .953168                   .926512                                                      
 6......................                     7                   .944069                   .917667                                                      
 7......................                     8                   .935056                                                                                
 8......................                     9                   .926129                                                                                
 9......................                    10                   .917287                                                                                
10......................                    11                   .908530                                                                                
11......................                    12                   .899856                                                                                
12......................  ........................               .891266                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(12.4).--With Interest at 12.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Montly period     
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .971614                   .957623                  .948370   
 1......................                     2                   .990306                   .962195                   .948340                  .939176   
 2......................                     3                   .980706                   .952868                   .939147                            
 3......................                     4                   .971199                   .943631                   .930043                            
 4......................                     5                   .961785                   .934484                                                      
 5......................                     6                   .952461                   .925425                                                      
 6......................                     7                   .943228                   .916454                                                      
 7......................                     8                   .934085                                                                                
 8......................                     9                   .925030                                                                                
 9......................                    10                   .916063                                                                                
10......................                    11                   .907183                                                                                
11......................                    12                   .898389                                                                                

[[Page 136]]

                                                                                                                                                        
12......................  ........................               .889680                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            TABLE F(12.6).--With Interest at 12.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                but less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .971195                   .957000                  .947614   
 1......................                     2                   .990159                   .961638                   .947583                  .938289   
 2......................                     3                   .980416                   .952175                   .938258                            
 3......................                     4                   .970768                   .942805                   .929025                            
 4......................                     5                   .961215                   .933527                                                      
 5......................                     6                   .951756                   .924341                                                      
 6......................                     7                   .942390                   .915245                                                      
 7......................                     8                   .933117                                                                                
 8......................                     9                   .923934                                                                                
 9......................                    10                   .914842                                                                                
10......................                    11                   .905840                                                                                
11......................                    12                   .896926                                                                                
12......................  ........................               .888099                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(12.8).--With Interest at 12.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                but less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .970777                   .956379                  .946860   
 1......................                     2                   .990013                   .961082                   .946828                  .937403   
 2......................                     3                   .980126                   .951484                   .937372                            
 3......................                     4                   .970337                   .941981                   .928011                            
 4......................                     5                   .960647                   .932574                                                      
 5......................                     6                   .951053                   .923260                                                      
 6......................                     7                   .941554                   .914040                                                      
 7......................                     8                   .932151                                                                                
 8......................                     9                   .922842                                                                                
 9......................                    10                   .913625                                                                                
10......................                    11                   .904501                                                                                
11......................                    12                   .895468                                                                                
12......................  ........................               .886525                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 137]]


            Table F(13.0).--With Interest at 13.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .970360                   .955760                  .946108   
 1......................                     2                   .989867                   .960528                   .946075                  .936521   
 2......................                     3                   .979836                   .950795                   .936489                            
 3......................                     4                   .969908                   .941160                   .926999                            
 4......................                     5                   .960079                   .931623                                                      
 5......................                     6                   .950351                   .922183                                                      
 6......................                     7                   .940721                   .912838                                                      
 7......................                     8                   .931188                                                                                
 8......................                     9                   .921753                                                                                
 9......................                    10                   .912412                                                                                
10......................                    11                   .903167                                                                                
11......................                    12                   .894015                                                                                
12......................  ........................               .884956                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(13.2).--With Interest at 13.2 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .969945                   .955143                  .945359   
 1......................                     2                   .989721                   .959975                   .945325                  .935641   
 2......................                     3                   .979548                   .950107                   .935608                            
 3......................                     4                   .969479                   .940341                   .925991                            
 4......................                     5                   .959514                   .930675                                                      
 5......................                     6                   .949651                   .921109                                                      
 6......................                     7                   .939889                   .911641                                                      
 7......................                     8                   .930228                                                                                
 8......................                     9                   .920667                                                                                
 9......................                    10                   .911203                                                                                
10......................                    11                   .901837                                                                                
11......................                    12                   .892567                                                                                
12......................  ........................               .883392                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(13.4).--With Interest at 13.4 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quaterly period           Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .969530                   .954527                  .944611   
 1......................                     2                   .989575                   .959423                   .944577                  .934764   
 2......................                     3                   .979260                   .949422                   .934730                            
 3......................                     4                   .969051                   .939524                   .924986                            
 4......................                     5                   .958949                   .929730                                                      
 5......................                     6                   .948953                   .920038                                                      
 6......................                     7                   .939060                   .910447                                                      
 7......................                     8                   .929271                                                                                
 8......................                     9                   .919584                                                                                
 9......................                    10                   .909998                                                                                
10......................                    11                   .900511                                                                                
11......................                    12                   .891124                                                                                
12......................  ........................               .881834                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 138]]


            Table F(13.6).--With Interest at 13.6 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
  1  Number of months by which the valuation date                              2 Factors for payout at the end of each period                           
   for the first full taxable year of the trust    -----------------------------------------------------------------------------------------------------
             precedes the first payout                                                                                                                  
---------------------------------------------------       Annual period           Semiannual period         Quaterly period           Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .969117                   .953913                  .943866   
 1......................                     2                   .989430                   .958873                   .943831                  .933890   
 2......................                     3                   .978972                   .948738                   .933854                            
 3......................                     4                   .968624                   .938710                   .923984                            
 4......................                     5                   .958386                   .928788                                                      
 5......................                     6                   .948256                   .918971                                                      
 6......................                     7                   .938233                   .909257                                                      
 7......................                     8                   .928316                                                                                
 8......................                     9                   .918504                                                                                
 9......................                    10                   .908796                                                                                
10......................                    11                   .899190                                                                                
11......................                    12                   .889686                                                                                
12......................  ........................               .880282                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(13.8).--With Interest at 13.8 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first full taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1                  1.000000                   .968704                   .953301                  .943123   
 1......................                     2                   .989285                   .958325                   .943087                  .933018   
 2......................                     3                   .978685                   .948056                   .932982                            
 3......................                     4                   .968199                   .937898                   .922985                            
 4......................                     5                   .957824                   .927849                                                      
 5......................                     6                   .947561                   .917907                                                      
 6......................                     7                   .937408                   .908072                                                      
 7......................                     8                   .927364                                                                                
 8......................                     9                   .917428                                                                                
 9......................                    10                   .907598                                                                                
10......................                    11                   .897873                                                                                
11......................                    12                   .888252                                                                                
12......................  ........................               .878735                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


            Table F(14.0).--With Interest at 14.0 Percent, Showing Factors for Computation of the Adjusted Payout Rate for Certain Valuations           
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
1 Number of months by which the valuation date for                             2 Factors for payout at the end of each period                           
 the first rull taxable year of the trust precedes -----------------------------------------------------------------------------------------------------
                 the first payout                                                                                                                       
---------------------------------------------------       Annual period           Semiannual period         Quarterly period          Monthly period    
        At least                But less than                                                                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                                        
                                             1                  1.000000                   .968293                   .952691                  .942382   
 1......................                     2                   .989140                   .957778                   .942345                  .932148   
 2......................                     3                   .978399                   .947377                   .932111                            
 3......................                     4                   .967774                   .937088                   .921989                            
 4......................                     5                   .957264                   .926912                                                      
 5......................                     6                   .946868                   .916846                                                      
 6......................                     7                   .936586                   .906889                                                      
 7......................                     8                   .926415                                                                                
 8......................                     9                   .916354                                                                                
 9......................                    10                   .906403                                                                                
10......................                    11                   .896560                                                                                
11......................                    12                   .886824                                                                                

[[Page 139]]

                                                                                                                                                        
12......................  ........................               .877193                                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 140]]


                                     Table U(1).--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors                                    
                                                            [Applicable After April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        4.2%      4.4%      4.6%      4.8%      5.0%      5.2%      5.4%      5.6%      5.8%      6.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .06797    .06181    .05645    .05177    .04768    .04410    .04096    .03820    .03578    .03364
1...................................................    .05881    .05243    .04686    .04199    .03773    .03400    .03072    .02784    .02531    .02308
2...................................................    .06049    .05394    .04821    .04319    .03880    .03494    .03155    .02856    .02593    .02361
3...................................................    .06252    .05579    .04990    .04473    .04020    .03621    .03270    .02961    .02688    .02446
4...................................................    .06479    .05788    .05182    .04650    .04183    .03771    .03408    .03087    .02804    .02553
5...................................................    .06724    .06016    .05393    .04845    .04363    .03937    .03562    .03230    .02936    .02675
6...................................................    .06984    .06257    .05618    .05054    .04557    .04117    .03729    .03385    .03080    .02809
7...................................................    .07259    .06513    .05856    .05276    .04764    .04310    .03909    .03552    .03236    .02954
8...................................................    .07548    .06784    .06109    .05513    .04985    .04517    .04102    .03733    .03405    .03113
9...................................................    .07854    .07071    .06378    .05765    .05221    .04738    .04310    .03928    .03588    .03285
10..................................................    .08176    .07374    .06663    .06033    .05473    .04976    .04533    .04138    .03786    .03471
11..................................................    .08517    .07695    .06966    .06319    .05743    .05230    .04772    .04364    .04000    .03673
12..................................................    .08872    .08031    .07284    .06619    .06026    .05498    .05026    .04604    .04227    .03889
13..................................................    .09238    .08378    .07612    .06929    .06320    .05776    .05289    .04853    .04463    .04113
14..................................................    .09608    .08728    .07943    .07243    .06616    .06056    .05554    .05104    .04701    .04338
15..................................................    .09981    .09081    .08276    .07557    .06914    .06337    .05820    .05356    .04938    .04563
16..................................................    .10356    .09435    .08612    .07874    .07213    .06619    .06086    .05607    .05176    .04787
17..................................................    .10733    .09792    .08949    .08192    .07513    .06902    .06353    .05858    .05413    .05010
18..................................................    .11117    .10155    .09291    .08515    .07817    .07189    .06623    .06113    .05652    .05236
19..................................................    .11509    .10526    .09642    .08847    .08130    .07484    .06901    .06375    .05899    .05469
20..................................................    .11913    .10908    .10003    .09188    .08452    .07788    .07188    .06645    .06154    .05708
21..................................................    .12326    .11300    .10375    .09539    .08784    .08101    .07483    .06923    .06416    .05955
22..................................................    .12753    .11705    .10758    .09902    .09127    .08426    .07789    .07212    .06688    .06212
23..................................................    .13195    .12125    .11156    .10279    .09484    .08763    .08109    .07514    .06973    .06481
24..................................................    .13655    .12563    .11573    .10675    .09860    .09119    .08446    .07833    .07274    .06766
25..................................................    .14136    .13022    .12010    .11091    .10255    .09495    .08802    .08171    .07595    .07069
26..................................................    .14640    .13504    .12471    .11530    .10674    .09893    .09181    .08531    .07937    .07394
27..................................................    .15169    .14011    .12956    .11994    .11117    .10316    .09584    .08915    .08302    .07742
28..................................................    .15721    .14542    .13465    .12482    .11583    .10762    .10010    .09322    .08691    .08112
29..................................................    .16299    .15097    .13999    .12994    .12075    .11233    .10461    .09753    .09104    .08507
30..................................................    .16901    .15678    .14559    .13533    .12592    .11729    .10937    .10210    .09541    .08926
31..................................................    .17531    .16287    .15146    .14099    .13137    .12254    .11441    .10694    .10006    .09372
32..................................................    .18186    .16921    .15759    .14691    .13709    .12804    .11972    .11205    .10497    .09844
33..................................................    .18869    .17584    .16401    .15312    .14309    .13384    .12531    .11744    .11017    .10345
34..................................................    .19578    .18273    .17070    .15961    .14937    .13992    .13119    .12312    .11565    .10874
35..................................................    .20315    .18990    .17767    .16637    .15593    .14628    .13735    .12908    .12142    .11431
36..................................................    .21076    .19732    .18490    .17340    .16276    .15291    .14377    .13531    .12745    .12016
37..................................................    .21863    .20501    .19239    .18071    .16987    .15982    .15049    .14182    .13377    .12628
38..................................................    .22676    .21296    .20016    .18828    .17725    .16701    .15748    .14862    .14037    .13269
39..................................................    .23515    .22118    .20820    .19614    .18492    .17448    .16476    .15571    .14727    .13940
40..................................................    .24379    .22967    .21652    .20428    .19288    .18225    .17234    .16310    .15447    .14641
41..................................................    .25270    .23842    .22511    .21270    .20112    .19031    .18021    .17078    .16197    .15372
42..................................................    .26184    .24742    .23395    .22137    .20962    .19864    .18836    .17875    .16975    .16132
43..................................................    .27123    .25666    .24305    .23031    .21840    .20724    .19679    .18700    .17782    .16921
44..................................................    .28085    .26616    .25241    .23952    .22745    .21613    .20551    .19554    .18618    .17739
45..................................................    .29072    .27591    .26203    .24901    .23678    .22530    .21452    .20438    .19485    .18589
46..................................................    .30082    .28591    .27191    .25875    .24639    .23476    .22381    .21352    .20382    .19468
47..................................................    .31116    .29616    .28204    .26877    .25626    .24449    .23340    .22295    .21309    .20379
48..................................................    .32171    .30663    .29241    .27902    .26640    .25449    .24326    .23265    .22264    .21318
49..................................................    .33245    .31730    .30300    .28950    .27676    .26473    .25336    .24262    .23246    .22285
50..................................................    .34338    .32816    .31379    .30020    .28735    .27521    .26371    .25283    .24253    .23277
51..................................................    .35449    .33923    .32479    .31112    .29818    .28593    .27431    .26331    .25287    .24297
52..................................................    .36582    .35053    .33603    .32230    .30927    .29692    .28520    .27408    .26352    .25349
53..................................................    .37736    .36205    .34751    .33372    .32063    .30819    .29637    .28514    .27446    .26431
54..................................................    .38909    .37376    .35921    .34537    .33221    .31970    .30780    .29647    .28569    .27542
55..................................................    .40099    .38568    .37111    .35724    .34404    .33146    .31949    .30807    .29719    .28681
56..................................................    .41308    .39779    .38322    .36934    .35610    .34348    .33143    .31994    .30898    .29851
57..................................................    .42536    .41011    .39555    .38167    .36841    .35575    .34366    .33210    .32106    .31051
58..................................................    .43781    .42262    .40810    .39422    .38096    .36828    .35615    .34454    .33344    .32281
59..................................................    .45043    .43530    .42083    .40698    .39373    .38104    .36888    .35724    .34609    .33540
60..................................................    .46318    .44813    .43372    .41992    .40668    .39400    .38183    .37017    .35898    .34824
61..................................................    .47602    .46107    .44674    .43299    .41979    .40713    .39497    .38329    .37207    .36129
62..................................................    .48893    .47410    .45986    .44617    .43303    .42039    .40825    .39657    .38534    .37454
63..................................................    .50190    .48720    .47306    .45946    .44638    .43379    .42168    .41001    .39878    .38796
64..................................................    .51494    .50038    .48636    .47286    .45986    .44733    .43526    .42362    .41240    .40158
65..................................................    .52808    .51368    .49980    .48641    .47350    .46104    .44903    .43743    .42624    .41544
66..................................................    .54134    .52711    .51338    .50013    .48733    .47496    .46302    .45148    .44033    .42956
67..................................................    .55471    .54068    .52712    .51401    .50134    .48908    .47723    .46577    .45467    .44394
68..................................................    .56820    .55437    .54100    .52805    .51552    .50339    .49165    .48027    .46925    .45858

[[Page 141]]

                                                                                                                                                        
69..................................................    .58172    .56812    .55495    .54219    .52982    .51783    .50620    .49494    .48401    .47341
70..................................................    .59526    .58190    .56894    .55637    .54417    .53234    .52086    .50971    .49889    .48838
71..................................................    .60874    .59564    .58291    .57055    .55854    .54687    .53554    .52453    .51382    .50342
72..................................................    .62218    .60934    .59685    .58471    .57291    .56143    .55026    .53939    .52882    .51854
73..................................................    .63557    .62301    .61078    .59887    .58728    .57600    .56501    .55431    .54389    .53373
74..................................................    .64896    .63669    .62472    .61307    .60171    .59064    .57985    .56932    .55906    .54906
75..................................................    .66237    .65040    .63872    .62733    .61622    .60538    .59480    .58447    .57439    .56455
76..................................................    .67581    .66416    .65279    .64168    .63083    .62023    .60988    .59977    .58989    .58023
77..................................................    .68925    .67793    .66688    .65606    .64550    .63516    .62506    .61517    .60551    .59605
78..................................................    .70263    .69166    .68093    .67044    .66016    .65010    .64026    .63062    .62119    .61195
79..................................................    .71585    .70525    .69486    .68468    .67471    .66495    .65538    .64600    .63681    .62780
80..................................................    .72885    .71860    .70856    .69872    .68906    .67959    .67031    .66120    .65227    .64350
81..................................................    .74150    .73162    .72193    .71242    .70308    .69392    .68492    .67609    .66742    .65890
82..................................................    .75376    .74425    .73490    .72572    .71671    .70785    .69915    .69059    .68219    .67393
83..................................................    .76559    .75643    .74744    .73859    .72989    .72134    .71293    .70466    .69652    .68852
84..................................................    .77700    .76821    .75955    .75104    .74266    .73441    .72629    .71831    .71044    .70270
85..................................................    .78805    .77961    .77130    .76311    .75505    .74711    .73929    .73158    .72399    .71652
86..................................................    .79866    .79056    .78258    .77472    .76697    .75933    .75180    .74438    .73707    .72985
87..................................................    .80870    .80094    .79329    .78574    .77829    .77095    .76370    .75656    .74951    .74255
88..................................................    .81825    .81081    .80348    .79623    .78908    .78202    .77506    .76818    .76139    .75469
89..................................................    .82746    .82035    .81332    .80638    .79952    .79275    .78606    .77945    .77292    .76647
90..................................................    .83643    .82963    .82291    .81627    .80971    .80322    .79681    .79047    .78420    .77801
91..................................................    .84503    .83854    .83212    .82578    .81950    .81330    .80716    .80109    .79509    .78915
92..................................................    .85308    .84689    .84076    .83470    .82870    .82276    .81689    .81107    .80532    .79963
93..................................................    .86052    .85460    .84875    .84295    .83721    .83152    .82590    .82033    .81481    .80935
94..................................................    .86729    .86163    .85602    .85046    .84496    .83951    .83412    .82877    .82348    .81823
95..................................................    .87338    .86795    .86257    .85723    .85195    .84672    .84153    .83639    .83129    .82624
96..................................................    .87877    .87354    .86836    .86323    .85814    .85309    .84809    .84313    .83822    .83334
97..................................................    .88365    .87861    .87362    .86867    .86375    .85888    .85405    .84926    .84450    .83979
98..................................................    .88805    .88318    .87835    .87356    .86880    .86409    .85941    .85477    .85016    .84559
99..................................................    .89210    .88739    .88271    .87807    .87347    .86890    .86436    .85986    .85539    .85095
100.................................................    .89588    .89131    .88678    .88227    .87780    .87337    .86896    .86459    .86024    .85593
101.................................................    .89949    .89506    .89066    .88629    .88195    .87764    .87336    .86911    .86488    .86069
102.................................................    .90325    .89897    .89471    .89047    .88627    .88209    .87794    .87381    .86971    .86564
103.................................................    .90724    .90311    .89900    .89491    .89085    .88681    .88279    .87880    .87484    .87089
104.................................................    .91167    .90770    .90376    .89983    .89593    .89205    .88819    .88435    .88053    .87673
105.................................................    .91708    .91333    .90959    .90587    .90217    .89848    .89481    .89116    .88752    .88391
106.................................................    .92470    .92126    .91782    .91440    .91100    .90760    .90422    .90085    .89749    .89414
107.................................................    .93545    .93246    .92948    .92650    .92353    .92057    .91762    .91467    .91173    .90880
108.................................................    .95239    .95016    .94792    .94569    .94346    .94123    .93900    .93678    .93456    .93234
109.................................................    .97900    .97800    .97700    .97600    .97500    .97400    .97300    .97200    .97100    .97000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 142]]


                                     Table U(1).--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors                                    
                                                            [Applicable After April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        6.2%      6.4%      6.6%      6.8%      7.0%      7.2%      7.4%      7.6%      7.8%      8.0%  
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .03176    .03009    .02861    .02730    .02613    .02509    .02416    .02333    .02258    .02191
1...................................................    .02110    .01936    .01781    .01644    .01522    .01413    .01316    .01229    .01150    .01080
2...................................................    .02156    .01974    .01812    .01669    .01541    .01427    .01325    .01234    .01152    .01078
3...................................................    .02233    .02043    .01875    .01725    .01591    .01471    .01364    .01268    .01182    .01105
4...................................................    .02330    .02132    .01956    .01800    .01660    .01535    .01422    .01322    .01231    .01149
5...................................................    .02443    .02237    .02054    .01890    .01743    .01612    .01494    .01389    .01293    .01208
6...................................................    .02568    .02353    .02162    .01990    .01837    .01700    .01576    .01465    .01365    .01275
7...................................................    .02704    .02480    .02280    .02102    .01941    .01798    .01668    .01552    .01446    .01351
8...................................................    .02852    .02619    .02411    .02224    .02057    .01906    .01770    .01648    .01537    .01437
9...................................................    .03014    .02772    .02554    .02360    .02184    .02027    .01885    .01756    .01640    .01535
10..................................................    .03190    .02938    .02711    .02508    .02325    .02160    .02012    .01877    .01755    .01645
11..................................................    .03381    .03119    .02883    .02672    .02481    .02308    .02153    .02012    .01884    .01768
12..................................................    .03585    .03313    .03068    .02847    .02648    .02468    .02305    .02157    .02023    .01902
13..................................................    .03798    .03515    .03260    .03030    .02822    .02635    .02464    .02310    .02170    .02042
14..................................................    .04012    .03718    .03453    .03213    .02997    .02801    .02623    .02462    .02315    .02181
15..................................................    .04225    .03919    .03644    .03395    .03169    .02965    .02779    .02611    .02457    .02317
16..................................................    .04436    .04120    .03833    .03574    .03339    .03126    .02932    .02756    .02595    .02449
17..................................................    .04647    .04319    .04021    .03752    .03507    .03285    .03082    .02898    .02730    .02577
18..................................................    .04860    .04519    .04210    .03930    .03675    .03443    .03232    .03040    .02864    .02703
19..................................................    .05079    .04725    .04404    .04113    .03847    .03606    .03386    .03185    .03001    .02833
20..................................................    .05304    .04938    .04604    .04301    .04025    .03773    .03543    .03333    .03141    .02965
21..................................................    .05537    .05157    .04811    .04495    .04208    .03945    .03705    .03486    .03285    .03101
22..................................................    .05779    .05385    .05025    .04698    .04398    .04125    .03874    .03645    .03435    .03242
23..................................................    .06032    .05623    .05250    .04910    .04598    .04313    .04052    .03812    .03592    .03390
24..................................................    .06302    .05878    .05491    .05136    .04812    .04515    .04242    .03992    .03762    .03550
25..................................................    .06589    .06150    .05748    .05380    .05042    .04733    .04448    .04187    .03946    .03725
26..................................................    .06897    .06442    .06025    .05643    .05292    .04969    .04673    .04400    .04148    .03916
27..................................................    .07228    .06757    .06325    .05928    .05563    .05227    .04917    .04632    .04369    .04126
28..................................................    .07582    .07094    .06646    .06234    .05854    .05504    .05182    .04884    .04609    .04355
29..................................................    .07958    .07454    .06990    .06562    .06167    .05804    .05468    .05157    .04870    .04604
30..................................................    .08360    .07838    .07357    .06913    .06504    .06125    .05775    .05452    .05152    .04874
31..................................................    .08788    .08249    .07751    .07291    .06866    .06472    .06108    .05771    .05457    .05167
32..................................................    .09242    .08685    .08170    .07694    .07252    .06844    .06465    .06113    .05786    .05483
33..................................................    .09724    .09149    .08617    .08124    .07666    .07242    .06848    .06482    .06141    .05824
34..................................................    .10234    .09641    .09091    .08581    .08107    .07667    .07257    .06876    .06521    .06191
35..................................................    .10773    .10161    .09594    .09066    .08575    .08119    .07694    .07298    .06928    .06583
36..................................................    .11338    .10708    .10122    .09577    .09070    .08597    .08156    .07744    .07360    .07001
37..................................................    .11932    .11283    .10680    .10117    .09592    .09102    .08645    .08217    .07818    .07444
38..................................................    .12554    .11887    .11265    .10685    .10142    .09636    .09162    .08719    .08304    .07915
39..................................................    .13206    .12521    .11880    .11282    .10722    .10198    .09708    .09249    .08818    .08414
40..................................................    .13888    .13184    .12526    .11909    .11332    .10791    .10284    .09808    .09361    .08942
41..................................................    .14601    .13878    .13201    .12567    .11972    .11414    .10890    .10398    .09935    .09499
42..................................................    .15342    .14601    .13906    .13254    .12641    .12066    .11525    .11016    .10537    .10086
43..................................................    .16112    .15353    .14640    .13970    .13340    .12747    .12189    .11663    .11168    .10701
44..................................................    .16913    .16136    .15406    .14718    .14070    .13460    .12885    .12342    .11830    .11347
45..................................................    .17745    .16951    .16202    .15497    .14832    .14204    .13612    .13053    .12525    .12025
46..................................................    .18608    .17796    .17030    .16308    .15625    .14981    .14372    .13796    .13251    .12735
47..................................................    .19501    .18673    .17890    .17150    .16451    .15790    .15164    .14571    .14010    .13478
48..................................................    .20425    .19579    .18780    .18024    .17308    .16630    .15987    .15378    .14800    .14252
49..................................................    .21375    .20514    .19698    .18926    .18193    .17499    .16840    .16214    .15620    .15056
50..................................................    .22352    .21476    .20644    .19856    .19107    .18396    .17721    .17080    .16470    .15890
51..................................................    .23358    .22467    .21620    .20816    .20051    .19325    .18634    .17976    .17350    .16755
52..................................................    .24396    .23490    .22628    .21809    .21030    .20288    .19581    .18908    .18267    .17655
53..................................................    .25465    .24545    .23670    .22836    .22042    .21285    .20563    .19875    .19218    .18592
54..................................................    .26563    .25631    .24742    .23895    .23086    .22315    .21579    .20876    .20204    .19562
55..................................................    .27692    .26747    .25846    .24986    .24164    .23379    .22628    .21911    .21225    .20568
56..................................................    .28850    .27895    .26982    .26109    .25275    .24476    .23712    .22981    .22281    .21611
57..................................................    .30041    .29076    .28152    .27267    .26421    .25610    .24833    .24089    .23376    .22691
58..................................................    .31263    .30288    .29355    .28460    .27602    .26780    .25991    .25234    .24508    .23811
59..................................................    .32515    .31532    .30590    .29685    .28817    .27984    .27184    .26416    .25677    .24968
60..................................................    .33793    .32803    .31853    .30940    .30062    .29219    .28409    .27630    .26880    .26159
61..................................................    .35093    .34098    .33141    .32220    .31335    .30483    .29663    .28873    .28113    .27381
62..................................................    .36414    .35414    .34451    .33524    .32631    .31771    .30942    .30144    .29374    .28631
63..................................................    .37754    .36750    .35783    .34850    .33951    .33084    .32247    .31440    .30661    .29910
64..................................................    .39115    .38108    .37137    .36200    .35296    .34422    .33579    .32765    .31978    .31217
65..................................................    .40500    .39493    .38519    .37579    .36670    .35792    .34943    .34122    .33328    .32560
66..................................................    .41914    .40906    .39932    .38990    .38079    .37197    .36343    .35517    .34717    .33943
67..................................................    .43355    .42350    .41376    .40434    .39521    .38636    .37780    .36950    .36145    .35365
68..................................................    .44824    .43822    .42851    .41909    .40996    .40111    .39252    .38419    .37611    .36827

[[Page 143]]

                                                                                                                                                        
69..................................................    .46313    .45316    .44348    .43409    .42498    .41613    .40754    .39919    .39109    .38322
70..................................................    .47818    .46827    .45864    .44929    .44020    .43137    .42279    .41445    .40634    .39845
71..................................................    .49331    .48348    .47391    .46461    .45557    .44677    .43821    .42988    .42177    .41388
72..................................................    .50853    .49879    .48930    .48007    .47108    .46233    .45380    .44550    .43741    .42952
73..................................................    .52384    .51421    .50482    .49566    .48674    .47805    .46957    .46130    .45324    .44538
74..................................................    .53930    .52979    .52050    .51145    .50261    .49399    .48557    .47736    .46934    .46152
75..................................................    .55495    .54557    .53641    .52747    .51873    .51020    .50187    .49372    .48577    .47799
76..................................................    .57079    .56157    .55256    .54374    .53513    .52670    .51847    .51041    .50253    .49483
77..................................................    .58680    .57775    .56890    .56024    .55176    .54346    .53534    .52739    .51960    .51198
78..................................................    .60291    .59405    .58537    .57687    .56855    .56040    .55241    .54458    .53691    .52940
79..................................................    .61898    .61032    .60184    .59353    .58537    .57738    .56954    .56185    .55431    .54691
80..................................................    .63491    .62647    .61819    .61007    .60210    .59428    .58660    .57907    .57167    .56441
81..................................................    .65054    .64234    .63427    .62636    .61858    .61094    .60344    .59606    .58882    .58170
82..................................................    .66582    .65784    .65000    .64229    .63472    .62727    .61994    .61274    .60566    .59870
83..................................................    .68065    .67291    .66530    .65781    .65044    .64319    .63605    .62903    .62212    .61532
84..................................................    .69508    .68758    .68020    .67293    .66577    .65872    .65178    .64495    .63821    .63158
85..................................................    .70915    .70190    .69475    .68770    .68076    .67392    .66718    .66054    .65399    .64754
86..................................................    .72274    .71573    .70882    .70200    .69528    .68865    .68212    .67567    .66931    .66304
87..................................................    .73569    .72892    .72224    .71565    .70915    .70273    .69639    .69014    .68397    .67788
88..................................................    .74807    .74154    .73509    .72872    .72243    .71622    .71009    .70403    .69805    .69214
89..................................................    .76010    .75381    .74759    .74144    .73537    .72937    .72344    .71758    .71179    .70607
90..................................................    .77189    .76584    .75985    .75394    .74809    .74230    .73659    .73093    .72534    .71981
91..................................................    .78327    .77746    .77171    .76603    .76040    .75484    .74933    .74388    .73850    .73316
92..................................................    .79399    .78841    .78289    .77743    .77202    .76667    .76137    .75613    .75093    .74579
93..................................................    .80394    .79858    .79328    .78803    .78283    .77768    .77258    .76753    .76252    .75757
94..................................................    .81303    .80788    .80278    .79773    .79272    .78776    .78284    .77797    .77315    .76837
95..................................................    .82124    .81628    .81136    .80649    .80166    .79687    .79213    .78742    .78276    .77814
96..................................................    .82851    .82372    .81897    .81426    .80959    .80496    .80036    .79581    .79129    .78682
97..................................................    .83512    .83048    .82588    .82132    .81679    .81230    .80785    .80343    .79905    .79471
98..................................................    .84106    .83656    .83210    .82767    .82328    .81892    .81459    .81030    .80604    .80181
99..................................................    .84655    .84218    .83785    .83354    .82927    .82503    .82082    .81664    .81249    .80837
100.................................................    .85165    .84740    .84318    .83899    .83483    .83070    .82660    .82252    .81848    .81446
101.................................................    .85652    .85238    .84827    .84419    .84013    .83611    .83210    .82813    .82418    .82026
102.................................................    .86159    .85757    .85358    .84960    .84566    .84174    .83784    .83397    .83012    .82630
103.................................................    .86697    .86307    .85920    .85535    .85152    .84771    .84392    .84016    .83642    .83270
104.................................................    .87295    .86919    .86544    .86172    .85802    .85434    .85068    .84704    .84341    .83981
105.................................................    .88030    .87672    .87315    .86959    .86605    .86253    .85903    .85554    .85207    .84861
106.................................................    .89081    .88749    .88418    .88088    .87760    .87433    .87106    .86782    .86458    .86135
107.................................................    .90588    .90296    .90005    .89715    .89425    .89137    .88849    .88561    .88275    .87989
108.................................................    .93013    .92791    .92570    .92350    .92129    .91909    .91689    .91469    .91250    .91031
109.................................................    .96900    .96800    .96700    .96600    .96500    .96400    .96300    .96200    .96100    .96000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 144]]


                                     Table U(1).--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors                                    
                                                            [Applicable after APRIL 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        8.2%      8.4%      8.6%      8.8%      9.0%      9.2%      9.4%      9.6%      9.8%      10.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .02130    .02075    .02025    .01980    .01939    .01901    .01867    .01835    .01806    .01779
1...................................................    .01017    .00960    .00908    .00861    .00819    .00780    .00745    .00712    .00683    .00655
2...................................................    .01011    .00951    .00897    .00848    .00803    .00762    .00725    .00690    .00659    .00630
3...................................................    .01035    .00971    .00914    .00862    .00815    .00771    .00732    .00696    .00663    .00632
4...................................................    .01076    .01009    .00948    .00894    .00843    .00798    .00756    .00718    .00683    .00650
5...................................................    .01130    .01059    .00996    .00938    .00885    .00836    .00792    .00752    .00714    .00680
6...................................................    .01193    .01119    .01051    .00990    .00934    .00883    .00836    .00793    .00754    .00717
7...................................................    .01265    .01187    .01116    .01051    .00992    .00938    .00888    .00842    .00800    .00762
8...................................................    .01347    .01264    .01189    .01121    .01058    .01001    .00948    .00900    .00856    .00815
9...................................................    .01440    .01353    .01274    .01201    .01135    .01075    .01019    .00968    .00921    .00877
10..................................................    .01544    .01453    .01369    .01293    .01223    .01159    .01101    .01046    .00997    .00950
11..................................................    .01662    .01566    .01478    .01398    .01324    .01257    .01195    .01137    .01085    .01036
12..................................................    .01791    .01690    .01597    .01513    .01435    .01364    .01298    .01238    .01182    .01131
13..................................................    .01926    .01820    .01722    .01634    .01552    .01477    .01408    .01344    .01285    .01231
14..................................................    .02059    .01948    .01846    .01752    .01667    .01588    .01515    .01448    .01386    .01328
15..................................................    .02189    .02072    .01965    .01867    .01777    .01694    .01617    .01547    .01481    .01421
16..................................................    .02315    .02192    .02080    .01977    .01882    .01795    .01714    .01640    .01572    .01508
17..................................................    .02436    .02308    .02190    .02082    .01982    .01891    .01806    .01728    .01656    .01589
18..................................................    .02556    .02422    .02298    .02184    .02080    .01983    .01894    .01812    .01736    .01665
19..................................................    .02679    .02537    .02408    .02288    .02178    .02077    .01983    .01897    .01817    .01742
20..................................................    .02804    .02656    .02519    .02394    .02278    .02172    .02073    .01982    .01898    .01819
21..................................................    .02932    .02776    .02633    .02501    .02380    .02268    .02164    .02068    .01979    .01896
22..................................................    .03065    .02902    .02751    .02613    .02485    .02367    .02258    .02157    .02063    .01976
23..................................................    .03204    .03033    .02876    .02730    .02595    .02471    .02356    .02249    .02150    .02058
24..................................................    .03356    .03176    .03010    .02857    .02716    .02585    .02463    .02351    .02246    .02149
25..................................................    .03520    .03332    .03158    .02997    .02848    .02710    .02582    .02463    .02352    .02249
26..................................................    .03702    .03504    .03321    .03152    .02995    .02850    .02714    .02589    .02472    .02363
27..................................................    .03902    .03695    .03502    .03324    .03159    .03006    .02863    .02730    .02607    .02492
28..................................................    .04120    .03902    .03700    .03513    .03339    .03178    .03027    .02887    .02757    .02635
29..................................................    .04358    .04129    .03917    .03720    .03537    .03367    .03208    .03061    .02923    .02794
30..................................................    .04616    .04376    .04154    .03947    .03754    .03575    .03408    .03251    .03106    .02969
31..................................................    .04897    .04646    .04413    .04195    .03993    .03804    .03627    .03463    .03309    .03165
32..................................................    .05200    .04938    .04693    .04465    .04252    .04053    .03867    .03693    .03531    .03378
33..................................................    .05529    .05254    .04998    .04758    .04534    .04325    .04130    .03946    .03775    .03614
34..................................................    .05883    .05595    .05326    .05075    .04840    .04620    .04414    .04221    .04040    .03870
35..................................................    .06262    .05961    .05680    .05417    .05170    .04939    .04723    .04520    .04329    .04149
36..................................................    .06665    .06351    .06057    .05781    .05523    .05280    .05053    .04839    .04638    .04449
37..................................................    .07094    .06766    .06459    .06171    .05900    .05646    .05407    .05182    .04971    .04771
38..................................................    .07550    .07208    .06888    .06586    .06303    .06037    .05786    .05550    .05327    .05118
39..................................................    .08034    .07678    .07344    .07029    .06733    .06454    .06191    .05943    .05709    .05489
40..................................................    .08547    .08177    .07828    .07499    .07190    .06898    .06623    .06363    .06118    .05886
41..................................................    .09090    .08704    .08341    .07998    .07675    .07371    .07083    .06811    .06553    .06310
42..................................................    .09661    .09260    .08882    .08525    .08188    .07870    .07569    .07284    .07015    .06760
43..................................................    .10260    .09844    .09451    .09080    .08729    .08397    .08083    .07785    .07503    .07236
44..................................................    .10891    .10459    .10051    .09666    .09300    .08954    .08626    .08316    .08021    .07741
45..................................................    .11553    .11106    .10683    .10282    .09902    .09542    .09201    .08876    .08568    .08276
46..................................................    .12247    .11784    .11346    .10930    .10536    .10161    .09806    .09468    .09146    .08841
47..................................................    .12974    .12496    .12042    .11611    .11202    .10813    .10443    .10091    .09756    .09438
48..................................................    .13732    .13238    .12769    .12323    .11899    .11495    .11111    .10745    .10397    .10065
49..................................................    .14520    .14011    .13526    .13064    .12625    .12207    .11809    .11429    .11066    .10721
50..................................................    .15338    .14812    .14312    .13836    .13381    .12948    .12535    .12141    .11765    .11405
51..................................................    .16187    .15646    .15130    .14639    .14169    .13721    .13294    .12885    .12495    .12121
52..................................................    .17072    .16516    .15985    .15478    .14993    .14531    .14088    .13665    .13261    .12873
53..................................................    .17993    .17422    .16876    .16353    .15854    .15377    .14920    .14482    .14064    .13662
54..................................................    .18949    .18362    .17801    .17264    .16750    .16258    .15787    .15335    .14902    .14486
55..................................................    .19940    .19339    .18763    .18212    .17683    .17176    .16690    .16224    .15777    .15348
56..................................................    .20968    .20353    .19762    .19196    .18654    .18132    .17632    .17152    .16691    .16247
57..................................................    .22035    .21406    .20802    .20222    .19665    .19129    .18615    .18121    .17646    .17189
58..................................................    .23142    .22499    .21881    .21287    .20717    .20168    .19640    .19132    .18643    .18172
59..................................................    .24286    .23630    .23000    .22393    .21809    .21247    .20705    .20184    .19682    .19198
60..................................................    .25465    .24797    .24154    .23534    .22938    .22363    .21808    .21274    .20759    .20262
61..................................................    .26676    .25996    .25341    .24710    .24101    .23513    .22946    .22399    .21871    .21361
62..................................................    .27916    .27225    .26559    .25916    .25295    .24695    .24117    .23557    .23017    .22495
63..................................................    .29184    .28483    .27806    .27152    .26520    .25909    .25319    .24748    .24196    .23661
64..................................................    .30483    .29772    .29085    .28421    .27779    .27157    .26555    .25973    .25409    .24863
65..................................................    .31817    .31098    .30402    .29729    .29076    .28444    .27832    .27240    .26665    .26108
66..................................................    .33192    .32466    .31762    .31079    .30418    .29777    .29155    .28552    .27968    .27400
67..................................................    .34609    .33876    .33164    .32474    .31805    .31156    .30525    .29913    .29319    .28742
68..................................................    .36066    .35328    .34610    .33914    .33238    .32581    .31943    .31323    .30720    .30134

[[Page 145]]

                                                                                                                                                        
69..................................................    .37558    .36815    .36093    .35391    .34709    .34045    .33400    .32773    .32163    .31569
70..................................................    .39078    .38332    .37606    .36900    .36213    .35545    .34894    .34260    .33643    .33042
71..................................................    .40620    .39872    .39144    .38435    .37744    .37071    .36415    .35776    .35153    .34547
72..................................................    .42184    .41435    .40706    .39994    .39301    .38625    .37965    .37322    .36694    .36082
73..................................................    .43771    .43023    .42293    .41581    .40886    .40207    .39545    .38899    .38267    .37651
74..................................................    .45387    .44641    .43912    .43201    .42505    .41826    .41163    .40514    .39881    .39261
75..................................................    .47039    .46296    .45570    .44861    .44167    .43488    .42824    .42175    .41541    .40920
76..................................................    .48729    .47991    .47269    .46563    .45872    .45196    .44534    .43886    .43251    .42630
77..................................................    .50452    .49722    .49006    .48305    .47619    .46946    .46287    .45642    .45009    .44389
78..................................................    .52203    .51481    .50773    .50079    .49399    .48732    .48078    .47437    .46808    .46191
79..................................................    .53966    .53254    .52556    .51870    .51198    .50538    .49891    .49255    .48632    .48019
80..................................................    .55728    .55028    .54340    .53665    .53002    .52351    .51712    .51083    .50466    .49860
81..................................................    .57471    .56784    .56109    .55445    .54792    .54151    .53521    .52901    .52292    .51692
82..................................................    .59186    .58512    .57850    .57199    .56558    .55927    .55307    .54697    .54097    .53506
83..................................................    .60863    .60204    .59556    .58918    .58289    .57671    .57062    .56462    .55872    .55290
84..................................................    .62505    .61862    .61228    .60604    .59989    .59383    .58786    .58198    .57618    .57047
85..................................................    .64118    .63491    .62873    .62263    .61663    .61070    .60486    .59911    .59343    .58783
86..................................................    .65685    .65075    .64473    .63879    .63294    .62716    .62145    .61583    .61027    .60479
87..................................................    .67187    .66594    .66008    .65430    .64859    .64296    .63739    .63190    .62647    .62112
88..................................................    .68631    .68054    .67485    .66923    .66367    .65818    .65276    .64740    .64211    .63688
89..................................................    .70042    .69483    .68930    .68384    .67845    .67311    .66784    .66262    .65747    .65237
90..................................................    .71434    .70894    .70359    .69830    .69307    .68790    .68278    .67772    .67271    .66775
91..................................................    .72789    .72266    .71750    .71239    .70733    .70232    .69736    .69246    .68760    .68280
92..................................................    .74070    .73567    .73068    .72574    .72085    .71601    .71121    .70647    .70176    .69711
93..................................................    .75266    .74780    .74298    .73821    .73348    .72880    .72417    .71957    .71502    .71051
94..................................................    .76363    .75893    .75428    .74967    .74510    .74057    .73608    .73163    .72722    .72285
95..................................................    .77356    .76901    .76451    .76005    .75562    .75123    .74688    .74257    .73829    .73405
96..................................................    .78237    .77797    .77360    .76927    .76497    .76071    .75648    .75229    .74813    .74401
97..................................................    .79039    .78612    .78187    .77766    .77348    .76934    .76523    .76115    .75710    .75308
98..................................................    .79762    .79345    .78932    .78522    .78115    .77711    .77310    .76913    .76518    .76126
99..................................................    .80429    .80023    .79620    .79220    .78823    .78429    .78038    .77649    .77264    .76881
100.................................................    .81047    .80651    .80258    .79867    .79479    .79094    .78712    .78332    .77955    .77580
101.................................................    .81636    .81249    .80865    .80483    .80104    .79727    .79352    .78981    .78611    .78244
102.................................................    .82250    .81872    .81497    .81124    .80754    .80386    .80020    .79656    .79295    .78936
103.................................................    .82900    .82532    .82167    .81804    .81442    .81083    .80726    .80371    .80018    .79667
104.................................................    .83622    .83266    .82911    .82558    .82207    .81858    .81510    .81165    .80821    .80479
105.................................................    .84517    .84174    .83833    .83494    .83156    .82819    .82485    .82151    .81820    .81489
106.................................................    .85814    .85494    .85175    .84857    .84540    .84225    .83911    .83598    .83286    .82975
107.................................................    .87704    .87420    .87136    .86853    .86571    .86290    .86009    .85729    .85450    .85171
108.................................................    .90812    .90593    .90375    .90156    .89939    .89721    .89504    .89286    .89070    .88853
109.................................................    .95900    .95800    .95700    .95600    .95500    .95400    .95300    .95200    .95100    .95000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 146]]


                                     Table U(1).--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors                                    
                                                            [Applicable after APRIL 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        10.2%     10.4%     10.6%     10.8%     11.0%     11.2%     11.4%     11.6%     11.8%     12.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01754    .01731    .01710    .01690    .01671    .01654    .01638    .01622    .01608    .01594
1...................................................    .00630    .00607    .00585    .00565    .00547    .00530    .00514    .00499    .00485    .00472
2...................................................    .00604    .00579    .00557    .00536    .00516    .00498    .00481    .00465    .00451    .00437
3...................................................    .00604    .00578    .00554    .00532    .00511    .00492    .00474    .00458    .00442    .00427
4...................................................    .00621    .00593    .00568    .00544    .00522    .00502    .00483    .00465    .00448    .00433
5...................................................    .00648    .00619    .00592    .00567    .00544    .00522    .00502    .00483    .00465    .00449
6...................................................    .00684    .00653    .00624    .00597    .00572    .00549    .00528    .00507    .00489    .00471
7...................................................    .00726    .00693    .00663    .00634    .00608    .00583    .00560    .00539    .00518    .00499
8...................................................    .00777    .00742    .00709    .00679    .00651    .00624    .00600    .00577    .00555    .00535
9...................................................    .00837    .00800    .00765    .00733    .00703    .00675    .00649    .00625    .00602    .00580
10..................................................    .00908    .00868    .00832    .00797    .00765    .00736    .00708    .00682    .00657    .00634
11..................................................    .00991    .00949    .00910    .00874    .00840    .00808    .00779    .00751    .00725    .00700
12..................................................    .01083    .01039    .00997    .00959    .00923    .00890    .00858    .00829    .00801    .00775
13..................................................    .01181    .01134    .01090    .01049    .01012    .00976    .00943    .00912    .00883    .00855
14..................................................    .01275    .01226    .01180    .01137    .01097    .01060    .01025    .00992    .00961    .00932
15..................................................    .01365    .01313    .01264    .01219    .01177    .01138    .01101    .01066    .01034    .01003
16..................................................    .01449    .01394    .01343    .01295    .01251    .01209    .01171    .01134    .01100    .01068
17..................................................    .01526    .01469    .01415    .01365    .01318    .01274    .01233    .01195    .01159    .01125
18..................................................    .01600    .01539    .01482    .01430    .01380    .01334    .01291    .01251    .01213    .01177
19..................................................    .01673    .01609    .01550    .01494    .01442    .01393    .01348    .01305    .01265    .01227
20..................................................    .01747    .01679    .01616    .01557    .01502    .01451    .01403    .01358    .01316    .01276
21..................................................    .01820    .01748    .01682    .01620    .01562    .01508    .01457    .01409    .01365    .01323
22..................................................    .01895    .01819    .01749    .01683    .01622    .01565    .01511    .01461    .01414    .01369
23..................................................    .01972    .01893    .01818    .01749    .01684    .01624    .01567    .01514    .01464    .01417
24..................................................    .02058    .01974    .01895    .01822    .01753    .01689    .01629    .01572    .01519    .01469
25..................................................    .02154    .02064    .01981    .01903    .01830    .01762    .01698    .01638    .01582    .01529
26..................................................    .02262    .02167    .02079    .01996    .01919    .01847    .01779    .01715    .01655    .01599
27..................................................    .02385    .02284    .02191    .02103    .02021    .01944    .01872    .01804    .01740    .01680
28..................................................    .02521    .02415    .02316    .02222    .02135    .02053    .01977    .01904    .01836    .01772
29..................................................    .02673    .02561    .02455    .02357    .02264    .02177    .02095    .02018    .01946    .01877
30..................................................    .02842    .02723    .02611    .02506    .02407    .02315    .02227    .02146    .02068    .01996
31..................................................    .03030    .02903    .02784    .02673    .02568    .02470    .02377    .02290    .02207    .02130
32..................................................    .03235    .03101    .02976    .02857    .02746    .02641    .02543    .02450    .02362    .02279
33..................................................    .03463    .03321    .03188    .03062    .02944    .02833    .02728    .02629    .02535    .02447
34..................................................    .03711    .03561    .03419    .03286    .03161    .03043    .02931    .02826    .02726    .02632
35..................................................    .03981    .03822    .03672    .03531    .03398    .03273    .03154    .03042    .02936    .02836
36..................................................    .04271    .04103    .03945    .03796    .03655    .03522    .03396    .03277    .03164    .03057
37..................................................    .04584    .04407    .04239    .04081    .03932    .03791    .03657    .03531    .03411    .03297
38..................................................    .04920    .04733    .04556    .04389    .04231    .04082    .03940    .03806    .03679    .03558
39..................................................    .05280    .05083    .04897    .04721    .04554    .04396    .04246    .04103    .03968    .03840
40..................................................    .05667    .05459    .05263    .05077    .04901    .04733    .04575    .04424    .04280    .04144
41..................................................    .06080    .05861    .05655    .05459    .05272    .05096    .04928    .04768    .04617    .04472
42..................................................    .06518    .06289    .06071    .05864    .05668    .05482    .05305    .05136    .04975    .04822
43..................................................    .06982    .06742    .06513    .06296    .06089    .05893    .05706    .05528    .05358    .05196
44..................................................    .07475    .07223    .06983    .06754    .06537    .06330    .06133    .05945    .05766    .05595
45..................................................    .07998    .07733    .07481    .07242    .07014    .06796    .06588    .06390    .06202    .06021
46..................................................    .08550    .08273    .08010    .07758    .07519    .07290    .07072    .06864    .06665    .06474
47..................................................    .09134    .08845    .08569    .08306    .08055    .07815    .07586    .07367    .07157    .06957
48..................................................    .09748    .09446    .09158    .08882    .08619    .08368    .08128    .07898    .07678    .07467
49..................................................    .10391    .10076    .09775    .09487    .09212    .08949    .08697    .08456    .08225    .08003
50..................................................    .11062    .10734    .10420    .10120    .09832    .09557    .09293    .09041    .08798    .08566
51..................................................    .11764    .11423    .11096    .10783    .10483    .10195    .09919    .09655    .09401    .09158
52..................................................    .12503    .12148    .11807    .11481    .11168    .10868    .10581    .10304    .10039    .09784
53..................................................    .13278    .12909    .12556    .12216    .11891    .11578    .11278    .10989    .10712    .10445
54..................................................    .14088    .13706    .13339    .12986    .12648    .12322    .12009    .11709    .11419    .11141
55..................................................    .14936    .14540    .14159    .13793    .13442    .13103    .12778    .12464    .12163    .11872
56..................................................    .15821    .15412    .15018    .14639    .14274    .13923    .13584    .13258    .12944    .12642
57..................................................    .16749    .16326    .15918    .15526    .15148    .14784    .14433    .14094    .13768    .13453
58..................................................    .17719    .17282    .16862    .16456    .16065    .15688    .15324    .14973    .14634    .14306
59..................................................    .18731    .18281    .17847    .17429    .17025    .16634    .16258    .15894    .15543    .15203
60..................................................    .19782    .19319    .18872    .18440    .18023    .17621    .17231    .16855    .16491    .16139
61..................................................    .20869    .20393    .19934    .19489    .19060    .18644    .18242    .17854    .17477    .17113
62..................................................    .21990    .21502    .21029    .20573    .20131    .19703    .19289    .18887    .18499    .18123
63..................................................    .23144    .22644    .22159    .21690    .21236    .20796    .20370    .19956    .19556    .19167
64..................................................    .24335    .23823    .23326    .22845    .22379    .21927    .21489    .21063    .20651    .20250
65..................................................    .25568    .25045    .24537    .24044    .23566    .23103    .22653    .22216    .21791    .21379
66..................................................    .26850    .26316    .25797    .25293    .24804    .24329    .23868    .23420    .22984    .22560
67..................................................    .28182    .27637    .27108    .26594    .26095    .25609    .25137    .24678    .24231    .23797
68..................................................    .29565    .29011    .28472    .27949    .27439    .26943    .26461    .25991    .25534    .25089

[[Page 147]]

                                                                                                                                                        
69..................................................    .30991    .30429    .29882    .29349    .28830    .28325    .27833    .27354    .26887    .26432
70..................................................    .32457    .31887    .31332    .30791    .30264    .29750    .29249    .28760    .28284    .27820
71..................................................    .33955    .33378    .32816    .32267    .31732    .31210    .30701    .30204    .29719    .29246
72..................................................    .35485    .34902    .34333    .33778    .33236    .32707    .32190    .31686    .31193    .30711
73..................................................    .37049    .36461    .35887    .35326    .34778    .34242    .33719    .33207    .32707    .32218
74..................................................    .38656    .38064    .37485    .36920    .36366    .35825    .35296    .34778    .34272    .33776
75..................................................    .40312    .39717    .39136    .38566    .38009    .37464    .36930    .36407    .35895    .35394
76..................................................    .42022    .41426    .40842    .40271    .39711    .39163    .38625    .38099    .37583    .37077
77..................................................    .43782    .43187    .42603    .42031    .41470    .40920    .40380    .39851    .39332    .38823
78..................................................    .45586    .44992    .44410    .43839    .43278    .42728    .42188    .41658    .41138    .40627
79..................................................    .47418    .46828    .46248    .45679    .45120    .44572    .44033    .43503    .42983    .42472
80..................................................    .49264    .48679    .48103    .47538    .46982    .46436    .45900    .45372    .44853    .44343
81..................................................    .51103    .50524    .49954    .49394    .48843    .48301    .47768    .47243    .46727    .46219
82..................................................    .52925    .52352    .51789    .51235    .50690    .50153    .49624    .49104    .48591    .48087
83..................................................    .54718    .54154    .53598    .53051    .52512    .51981    .51459    .50943    .50436    .49936
84..................................................    .56484    .55930    .55383    .54844    .54313    .53789    .53273    .52764    .52262    .51767
85..................................................    .58231    .57686    .57149    .56619    .56096    .55581    .55072    .54571    .54076    .53588
86..................................................    .59939    .59405    .58878    .58358    .57845    .57339    .56839    .56346    .55858    .55377
87..................................................    .61583    .61061    .60545    .60035    .59532    .59035    .58545    .58060    .57581    .57108
88..................................................    .63171    .62661    .62156    .61658    .61165    .60678    .60196    .59721    .59251    .58786
89..................................................    .64733    .64235    .63742    .63255    .62774    .62298    .61827    .61361    .60900    .60444
90..................................................    .66285    .65801    .65321    .64847    .64377    .63913    .63453    .62998    .62548    .62103
91..................................................    .67804    .67334    .66868    .66407    .65950    .65498    .65050    .64607    .64169    .63735
92..................................................    .69250    .68793    .68341    .67893    .67450    .67011    .66575    .66144    .65718    .65295
93..................................................    .70604    .70162    .69723    .69288    .68858    .68431    .68008    .67589    .67174    .66762
94..................................................    .71852    .71422    .70997    .70575    .70156    .69742    .69331    .68923    .68519    .68119
95..................................................    .72984    .72567    .72154    .71744    .71337    .70934    .70534    .70137    .69744    .69354
96..................................................    .73992    .73586    .73183    .72784    .72388    .71995    .71605    .71218    .70835    .70454
97..................................................    .74910    .74514    .74122    .73733    .73346    .72963    .72582    .72205    .71830    .71458
98..................................................    .75737    .75351    .74967    .74587    .74209    .73835    .73463    .73093    .72727    .72363
99..................................................    .76501    .76123    .75748    .75376    .75007    .74640    .74276    .73914    .73555    .73198
100.................................................    .77208    .76838    .76471    .76107    .75745    .75385    .75028    .74673    .74321    .73971
101.................................................    .77879    .77517    .77157    .76800    .76444    .76092    .75741    .75392    .75046    .74702
102.................................................    .78579    .78224    .77871    .77521    .77173    .76827    .76483    .76141    .75801    .75463
103.................................................    .79318    .78971    .78626    .78283    .77942    .77604    .77266    .76931    .76598    .76267
104.................................................    .80139    .79801    .79464    .79129    .78796    .78465    .78136    .77808    .77482    .77157
105.................................................    .81161    .80834    .80508    .80184    .79861    .79540    .79220    .78902    .78585    .78270
106.................................................    .82665    .82357    .82049    .81743    .81438    .81134    .80831    .80530    .80229    .79930
107.................................................    .84893    .84616    .84340    .84064    .83789    .83515    .83241    .82969    .82696    .82425
108.................................................    .88637    .88421    .88205    .87989    .87774    .87559    .87344    .87129    .86915    .86701
109.................................................    .94900    .94800    .94700    .94600    .94500    .94400    .94300    .94200    .94100    .94000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 148]]


                                     Table U(1).--Based on Life Table 80CNSMT Unitrust Single Life Remainder Factors                                    
                                                            [Applicable after April 30, 1989]                                                           
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                             Adjusted payout rate                                       
                         Age                         ---------------------------------------------------------------------------------------------------
                                                        12.2%     12.4%     12.6%     12.8%     13.0%     13.2%     13.4%     13.6%     13.8%     14.0% 
--------------------------------------------------------------------------------------------------------------------------------------------------------
0...................................................    .01581    .01569    .01557    .01546    .01536    .01526    .01516    .01507    .01499    .01490
1...................................................    .00459    .00448    .00437    .00426    .00417    .00407    .00399    .00390    .00382    .00375
2...................................................    .00424    .00412    .00400    .00389    .00379    .00369    .00360    .00352    .00343    .00335
3...................................................    .00414    .00401    .00389    .00377    .00366    .00356    .00346    .00337    .00328    .00320
4...................................................    .00418    .00404    .00391    .00379    .00368    .00357    .00347    .00337    .00327    .00319
5...................................................    .00433    .00418    .00405    .00391    .00379    .00368    .00357    .00346    .00336    .00327
6...................................................    .00454    .00439    .00424    .00410    .00397    .00384    .00372    .00361    .00351    .00341
7...................................................    .00482    .00465    .00449    .00434    .00420    .00407    .00394    .00382    .00371    .00360
8...................................................    .00516    .00498    .00481    .00465    .00450    .00436    .00422    .00410    .00397    .00386
9...................................................    .00560    .00541    .00523    .00505    .00489    .00474    .00459    .00446    .00433    .00420
10..................................................    .00613    .00592    .00573    .00555    .00537    .00521    .00505    .00491    .00477    .00463
11..................................................    .00677    .00655    .00635    .00615    .00597    .00580    .00563    .00547    .00532    .00518
12..................................................    .00751    .00728    .00706    .00685    .00666    .00647    .00629    .00613    .00597    .00581
13..................................................    .00829    .00805    .00782    .00760    .00739    .00719    .00701    .00683    .00666    .00650
14..................................................    .00905    .00879    .00854    .00831    .00809    .00789    .00769    .00750    .00732    .00715
15..................................................    .00974    .00947    .00921    .00897    .00874    .00852    .00831    .00811    .00793    .00775
16..................................................    .01037    .01009    .00982    .00956    .00932    .00909    .00887    .00866    .00846    .00827
17..................................................    .01093    .01063    .01034    .01007    .00982    .00958    .00935    .00913    .00892    .00873
18..................................................    .01143    .01112    .01082    .01053    .01027    .01001    .00977    .00954    .00933    .00912
19..................................................    .01192    .01159    .01127    .01097    .01069    .01043    .01017    .00993    .00970    .00949
20..................................................    .01239    .01204    .01170    .01139    .01109    .01081    .01055    .01029    .01005    .00983
21..................................................    .01283    .01246    .01211    .01178    .01147    .01117    .01089    .01063    .01037    .01013
22..................................................    .01328    .01288    .01251    .01216    .01183    .01152    .01122    .01094    .01067    .01042
23..................................................    .01372    .01331    .01292    .01254    .01219    .01186    .01155    .01125    .01097    .01070
24..................................................    .01422    .01378    .01336    .01297    .01260    .01225    .01191    .01160    .01130    .01101
25..................................................    .01479    .01432    .01388    .01346    .01306    .01269    .01233    .01200    .01168    .01138
26..................................................    .01545    .01495    .01448    .01404    .01362    .01322    .01284    .01248    .01214    .01182
27..................................................    .01623    .01570    .01520    .01472    .01427    .01385    .01344    .01306    .01270    .01235
28..................................................    .01712    .01655    .01601    .01551    .01503    .01457    .01414    .01373    .01334    .01298
29..................................................    .01813    .01752    .01695    .01641    .01589    .01541    .01494    .01451    .01409    .01370
30..................................................    .01927    .01862    .01801    .01743    .01688    .01635    .01586    .01539    .01495    .01452
31..................................................    .02056    .01987    .01922    .01859    .01801    .01745    .01692    .01642    .01594    .01548
32..................................................    .02201    .02127    .02057    .01990    .01927    .01868    .01811    .01757    .01706    .01657
33..................................................    .02363    .02284    .02209    .02138    .02071    .02007    .01946    .01888    .01833    .01781
34..................................................    .02543    .02458    .02378    .02302    .02230    .02162    .02096    .02034    .01975    .01919
35..................................................    .02741    .02651    .02565    .02484    .02407    .02333    .02264    .02197    .02134    .02073
36..................................................    .02956    .02859    .02768    .02681    .02599    .02520    .02446    .02374    .02307    .02242
37..................................................    .03189    .03087    .02990    .02897    .02809    .02725    .02645    .02569    .02496    .02427
38..................................................    .03443    .03334    .03230    .03131    .03037    .02948    .02862    .02781    .02703    .02628
39..................................................    .03718    .03602    .03491    .03386    .03285    .03190    .03099    .03011    .02928    .02849
40..................................................    .04015    .03891    .03774    .03662    .03555    .03453    .03355    .03262    .03173    .03088
41..................................................    .04335    .04204    .04079    .03959    .03846    .03737    .03633    .03534    .03439    .03348
42..................................................    .04677    .04538    .04405    .04278    .04157    .04042    .03931    .03825    .03724    .03627
43..................................................    .05042    .04894    .04754    .04619    .04491    .04368    .04250    .04138    .04030    .03926
44..................................................    .05432    .05276    .05127    .04984    .04848    .04718    .04593    .04473    .04358    .04248
45..................................................    .05849    .05684    .05526    .05375    .05231    .05092    .04960    .04832    .04710    .04593
46..................................................    .06292    .06118    .05952    .05792    .05639    .05492    .05352    .05217    .05087    .04963
47..................................................    .06765    .06581    .06405    .06237    .06075    .05920    .05771    .05628    .05491    .05359
48..................................................    .07265    .07071    .06886    .06708    .06537    .06373    .06216    .06064    .05919    .05779
49..................................................    .07791    .07587    .07392    .07204    .07024    .06851    .06685    .06525    .06371    .06223
50..................................................    .08343    .08129    .07923    .07726    .07536    .07354    .07178    .07009    .06847    .06690
51..................................................    .08924    .08699    .08483    .08276    .08076    .07884    .07699    .07520    .07349    .07183
52..................................................    .09539    .09303    .09076    .08858    .08648    .08446    .08251    .08064    .07883    .07708
53..................................................    .10189    .09942    .09704    .09475    .09255    .09043    .08838    .08640    .08450    .08266
54..................................................    .10872    .10614    .10365    .10126    .09894    .09672    .09456    .09249    .09049    .08855
55..................................................    .11592    .11322    .11062    .10811    .10569    .10335    .10110    .09892    .09682    .09478
56..................................................    .12350    .12068    .11796    .11534    .11281    .11036    .10800    .10571    .10350    .10137
57..................................................    .13148    .12855    .12572    .12298    .12033    .11777    .11530    .11291    .11060    .10836
58..................................................    .13990    .13685    .13389    .13104    .12828    .12561    .12303    .12053    .11811    .11576
59..................................................    .14875    .14557    .14250    .13953    .13665    .13387    .13118    .12856    .12604    .12359
60..................................................    .15799    .15469    .15150    .14841    .14542    .14253    .13972    .13700    .13436    .13180
61..................................................    .16761    .16419    .16088    .15768    .15457    .15156    .14864    .14580    .14305    .14039
62..................................................    .17758    .17404    .17062    .16729    .16407    .16094    .15791    .15496    .15210    .14932
63..................................................    .18791    .18425    .18071    .17726    .17392    .17068    .16753    .16447    .16150    .15861
64..................................................    .19862    .19484    .19118    .18762    .18417    .18081    .17754    .17437    .17129    .16829
65..................................................    .20979    .20590    .20212    .19845    .19487    .19140    .18802    .18474    .18154    .17843
66..................................................    .22149    .21748    .21359    .20980    .20612    .20253    .19904    .19564    .19233    .18911
67..................................................    .23374    .22962    .22562    .22172    .21792    .21423    .21062    .20712    .20370    .20037
68..................................................    .24656    .24234    .23822    .23422    .23031    .22651    .22280    .21919    .21566    .21222

[[Page 149]]

                                                                                                                                                        
69..................................................    .25988    .25556    .25134    .24724    .24323    .23932    .23551    .23179    .22816    .22461
70..................................................    .27367    .26925    .26493    .26073    .25662    .25261    .24870    .24488    .24115    .23750
71..................................................    .28784    .28333    .27892    .27462    .27042    .26631    .26230    .25839    .25456    .25082
72..................................................    .30241    .29781    .29332    .28893    .28464    .28044    .27634    .27233    .26841    .26457
73..................................................    .31740    .31272    .30815    .30368    .29930    .29502    .29084    .28674    .28273    .27880
74..................................................    .33291    .32817    .32352    .31897    .31452    .31016    .30589    .30171    .29762    .29361
75..................................................    .34903    .34422    .33951    .33490    .33038    .32595    .32161    .31735    .31318    .30909
76..................................................    .36581    .36095    .35619    .35152    .34694    .34245    .33805    .33373    .32949    .32533
77..................................................    .38324    .37835    .37354    .36883    .36420    .35966    .35520    .35083    .34654    .34232
78..................................................    .40126    .39634    .39150    .38676    .38210    .37752    .37302    .36861    .36427    .36001
79..................................................    .41970    .41476    .40992    .40515    .40047    .39587    .39135    .38690    .38253    .37823
80..................................................    .43842    .43348    .42864    .42387    .41918    .41456    .41002    .40556    .40117    .39685
81..................................................    .45719    .45228    .44744    .44267    .43799    .43337    .42883    .42436    .41996    .41562
82..................................................    .47590    .47101    .46619    .46145    .45677    .45217    .44764    .44317    .43877    .43443
83..................................................    .49443    .48957    .48478    .48007    .47542    .47084    .46632    .46187    .45748    .45315
84..................................................    .51279    .50798    .50324    .49856    .49394    .48939    .48490    .48048    .47611    .47180
85..................................................    .53106    .52630    .52161    .51698    .51241    .50790    .50345    .49906    .49473    .49045
86..................................................    .54902    .54434    .53971    .53514    .53062    .52616    .52176    .51741    .51312    .50888
87..................................................    .56640    .56178    .55722    .55271    .54826    .54386    .53951    .53521    .53097    .52677
88..................................................    .58326    .57872    .57423    .56979    .56541    .56107    .55678    .55254    .54834    .54420
89..................................................    .59994    .59548    .59107    .58671    .58240    .57813    .57391    .56973    .56560    .56152
90..................................................    .61662    .61226    .60794    .60367    .59944    .59526    .59112    .58702    .58296    .57894
91..................................................    .63305    .62879    .62457    .62040    .61627    .61217    .60812    .60411    .60013    .59619
92..................................................    .64876    .64461    .64050    .63643    .63239    .62839    .62443    .62051    .61662    .61277
93..................................................    .66355    .65950    .65550    .65153    .64759    .64369    .63983    .63600    .63220    .62843
94..................................................    .67722    .67328    .66938    .66551    .66167    .65786    .65409    .65035    .64664    .64296
95..................................................    .68967    .68583    .68203    .67825    .67451    .67079    .66711    .66345    .65983    .65623
96..................................................    .70076    .69701    .69330    .68961    .68595    .68231    .67871    .67513    .67158    .66806
97..................................................    .71089    .70722    .70359    .69998    .69640    .69284    .68931    .68581    .68234    .67888
98..................................................    .72001    .71642    .71286    .70933    .70582    .70233    .69887    .69544    .69203    .68864
99..................................................    .72844    .72492    .72143    .71796    .71452    .71110    .70770    .70433    .70098    .69765
100.................................................    .73623    .73278    .72935    .72594    .72256    .71920    .71586    .71254    .70924    .70597
101.................................................    .74361    .74021    .73684    .73349    .73016    .72685    .72356    .72029    .71704    .71382
102.................................................    .75128    .74794    .74463    .74133    .73806    .73480    .73157    .72835    .72515    .72198
103.................................................    .75938    .75610    .75284    .74961    .74639    .74319    .74000    .73684    .73369    .73056
104.................................................    .76835    .76514    .76194    .75877    .75561    .75246    .74934    .74623    .74313    .74005
105.................................................    .77956    .77643    .77332    .77023    .76714    .76408    .76102    .75798    .75496    .75195
106.................................................    .79632    .79334    .79038    .78743    .78449    .78157    .77865    .77575    .77285    .76997
107.................................................    .82154    .81884    .81615    .81346    .81079    .80811    .80545    .80279    .80014    .79750
108.................................................    .86487    .86274    .86061    .85848    .85635    .85423    .85210    .84998    .84787    .84575
109.................................................    .93900    .93800    .93700    .93600    .93500    .93400    .93300    .93200    .93100    .93000
--------------------------------------------------------------------------------------------------------------------------------------------------------


[[Page 150]]

    (f) Effective date. This section is effective as of May 1, 1989.

[T.D. 8540, 59 FR 30117, June 10, 1994]

         Unitrust Actuarial Tables Applicable Before May 1, 1989



Sec. 1.664-4A  Valuation of charitable remainder interests for which the valuation date is before May 1, 1989.

    (a) Valuation of charitable remainder interests for which the 
valuation date is before January 1, 1952. There was no provision for the 
qualification of a charitable remainder unitrust under section 664 until 
1969. See Sec. 20.2031-7A(a) of this chapter (Estate Tax Regulations) 
for the determination of the present value of a charitable interest for 
which the valuation date is before January 1, 1952.
    (b) Valuation of charitable remainder interests for which the 
valuation date is after December 31, 1951, and before January 1, 1971. 
No charitable deduction is allowable for a transfer to a unitrust for 
which the valuation date is after the effective dates of the Tax Reform 
Act of 1969 unless the unitrust meets the requirements of section 664. 
See Sec. 20.2031-7A(b) of this chapter (Estate Tax Regulations) for the 
determination of the present value of a charitable remainder interest 
for which the valuation date is after December 31, 1951, and before 
January 1, 1971.
    (c) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
December 31, 1970, and before December 1, 1983. For the determination of 
the present value of a charitable remainder unitrust for which the 
valuation date is after December 31, 1970, and before December 1, 1983, 
see Sec. 20.2031-7A(c) of this chapter (Estate Tax Regulations) and 
former Sec. 1.664-4(d) (as contained in the 26 CFR part 1 edition 
revised as of April 1, 1994).
    (d) Valuation of charitable remainder unitrusts having certain 
payout sequences for transfers for which the valuation date is after 
November 30, 1983, and before May 1, 1989--(1) In general. Except as 
otherwise provided in paragraph (d)(2) of this section, in the case of 
transfers made after November 30, 1983, for which the valuation date is 
before May 1, 1989, the present value of a remainder interest that is 
dependent on a term of years or the termination of the life of one 
individual is determined under paragraphs (d)(3) through (d)(6) of this 
section, provided that the amount of the payout as of any payout date 
during any taxable year of the trust is not larger than the amount that 
the trust could distribute on such date under Sec. 1.664-3(a)(1)(v) if 
the taxable year of the trust were to end on such date. The present 
value of the remainder interest in the trust is determined by computing 
the adjusted payout rate (as defined in paragraph (d)(3) of this 
section) and following the procedure outlined in paragraph (d)(4) or 
(d)(5) of this section, whichever is applicable. The present value of a 
remainder interest that is dependent on a term of years is computed 
under paragraph (d)(4) of this section. The present value of a remainder 
interest that is dependent on the termination of the life of one 
individual is computed under paragraph (d)(5) of this section. See 
paragraph (d)(2) of this section for testamentary transfers for which 
the valuation date is after November 30, 1983, and before August 9, 
1984.
    (2) Rules for determining the present value for testamentary 
transfers where the decedent dies after November 30, 1983, and before 
August 9, 1984. For purposes of section 2055 or 2106, if--
    (i) The decedent dies after November 30, 1983, and before August 9, 
1984; or
    (ii) On December 1, 1983, the decedent was mentally incompetent so 
that the disposition of the property could not be changed, and the 
decedent died after November 30, 1983, without regaining competency to 
dispose of the decedent's property, or died within 90 days of the date 
on which the decedent first regained competency, the present value 
determined under this section of a remainder interest is determined in 
accordance with paragraph (d)(1) and paragraphs (d)(3) through (d)(6) of 
this section, or Sec. 1.664-4A(c), at the option of the taxpayer.
    (3) Adjusted payout rate. The adjusted payout rate is determined by 
multiplying the fixed percentage described in paragraph (a)(1)(i)(a) of 
Sec. 1.664-3 by the figure in column (2) of Table F(1) which describes 
the payout sequence of the

[[Page 151]]

trust opposite the number in column (1) of Table F(1) which corresponds 
to the number of months by which the valuation date for the first full 
taxable year of the trust precedes the first payout date for such 
taxable year. If the governing instrument does not prescribe when the 
distribution shall be made during the taxable year of the trust, see 
Sec. 1.664-4(a). In the case of a trust having a payout sequence for 
which no figures have been provided by Table F (1) and in the case of a 
trust which determines the fair market value of the trust assets by 
taking the average of valuations on more than one date during the 
taxable year, see Sec. 1.664-4(b).
    (4) Period is a term of years. If the period described in paragraph 
(a)(5) of Sec. 1.664-3 is a term of years, the factor which is used in 
determining the present value of the remainder interest is the factor 
under the appropriate adjusted payout rate in column (2) of Table D in 
paragraph (d)(6) of this section opposite the number in column (1) of 
Table D which corresponds to the number of years in the term. If the 
adjusted payout rate is an amount which is between adjusted payout rates 
for which factors are provided in Table D, a linear interpolation must 
be made. The present value of the remainder interest is determined by 
multiplying the net fair market value (as of the appropriate valuation 
date) of the property placed in trust by the factor determined under 
this paragraph (d)(4). For purposes of this section, the term 
appropriate valuation date means the date on which the property is 
transferred to the trust by the donor except that, for purposes of 
section 2055 or 2106, it means the date of death unless the alternate 
valuation date is elected in accordance with section 2032 and the 
regulations thereunder in which event it means the alternate valuation 
date. If the adjusted payout rate is greater than 14 percent, see 
Sec. 1.664-4(b). The application of this paragraph (d)(4) may be 
illustrated by the following example:

    Example. D transfers $100,000 to a charitable remainder unitrust on 
January 1, 1985. The trust instrument requires that the trust pay to D 
semiannually (on June 30 and December 31) 10 percent of the fair market 
value of the trust assets as of June 30th for a term of 15 years. The 
adjusted payout rate is 9.767 percent (10% x 0.976731). The present 
value of the remainder interest is $21,404.90, computed as follows:

Factor at 9.6 percent for 15 years............................  0.220053
Factor at 9.8 percent for 15 years............................   .212862
                                                               ---------
    Difference................................................   .007191
                                                                        


                                                                                                                
                                                   9.767%-9.6%            X                                     
                                               ------------------  = ----------                                 
                                                      0.2%             .007191                                  
                                                                                                                

              9.767%- 9.6 0.2%= x  .007191

X = .006004

Factor at 9.6 percent for 15 years......................        0.220053
Less: X.................................................         .006004
    Interpolated factor.................................         .214049
                                                                        
Present value of remainder interest=$100,000 x 0.214049=                
 $21,404.90                                                             
                                                                        

    (5) Period is the life of one individual. If the period described in 
paragraph (a)(5) of Sec. 1.664-3 is the life of one individual, the 
factor that is used in determining the present value of the remainder 
interest is the factor under the appropriate adjusted payout rate in 
column (2) of Table E in paragraph (d)(6) of this section opposite the 
number in column (1) that corresponds to the age of the individual whose 
life measures the period. For purposes of the computations described in 
this paragraph (b)(5), the age of an individual is to be taken as the 
age of that individual at the individual's nearest birthday. If the 
adjusted payout rate is an amount which is between adjusted payout rates 
for which factors are provided for in Table E, a linear interpolation 
must be made. The present value of the remainder interest is determined 
by multiplying the net fair market value (as of the appropriate 
valuation date) of the property placed in trust by the factor determined 
under this paragraph (b)(5). If the adjusted payout rate is greater than 
14 percent, see Sec. 1.664-4(b). The application of this paragraph may 
be illustrated by the following example:

    Example. A, who will be 50 years old on April 15, 1985, transfers 
$100,000 to a charitable remainder unitrust on January 1, 1985. The 
trust instrument requires that the trust pay to A at the end of each 
taxable year of the trust 10 percent of the fair market value of the 
trust assets as of the beginning of

[[Page 152]]

each taxable year of the trust. The adjusted payout rate is 9.091 
percent (10 percent  x  .909091). The present value of the remainder 
interest is $15,259.00 computed as follows:

Factor at 9 percent at age 50.................................   0.15472
Factor at 9.2 percent at age 50...............................    .15003
                                                               ---------
    Difference................................................    .00469
                                                                        
                 9.091%-9%0.2%=X0.00469                 
                                x=0.00213                               
                                                                        
Factor at 9 percent at age 50.................................    .15472
Less: X.......................................................    .00213
                                                               ---------
    Interpolated factor.......................................    .15259
                                                                        
                  Present value of remainder interest=                  
                      $100,000 x 0.15259=$15,259.00                     
                                                                        

    (6) Actuarial tables for transfers for which the valuation date is 
after November 30, 1983, and before May 1, 1989. The following tables 
shall be used in the application of the provisions of this section:

                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  2.2%      2.4%      2.6%      2.8%      3.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .978000   .976000   .974000   .972000   .970000
2.............................................................   .956484   .952576   .948676   .944784   .940900
3.............................................................   .935441   .929714   .924010   .918330   .912673
4.............................................................   .914862   .907401   .899986   .892617   .885293
5.............................................................   .894735   .885623   .876587   .867624   .858734
6.............................................................   .875051   .864368   .853795   .843330   .832972
7.............................................................   .855799   .843624   .831597   .819717   .807983
8.............................................................   .836972   .823377   .809975   .796765   .783743
9.............................................................   .818558   .803616   .788916   .774455   .760231
10............................................................   .800550   .784329   .768404   .752771   .737424
11............................................................   .782938   .765505   .748425   .731693   .715301
12............................................................   .765713   .747133   .728966   .711206   .693842
13............................................................   .748868   .729202   .710013   .691292   .673027
14............................................................   .732393   .711701   .691553   .671936   .652836
15............................................................   .716280   .694620   .673573   .653121   .633251
16............................................................   .700522   .677949   .656060   .634834   .614254
17............................................................   .685110   .661678   .639002   .617059   .595826
18............................................................   .670038   .645798   .622388   .599781   .577951
19............................................................   .655297   .630299   .606206   .582987   .560613
20............................................................   .640881   .615172   .590445   .566664   .543794
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  3.2%      3.4%      3.6%      3.8%      4.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .968000   .966000   .964000   .962000   .960000
2.............................................................   .937024   .933156   .929296   .925444   .921600
3.............................................................   .907039   .901429   .895841   .890277   .884736
4.............................................................   .878014   .870780   .863591   .856447   .849347
5.............................................................   .849918   .841174   .832502   .823902   .815373
6.............................................................   .822720   .812574   .802532   .792593   .782758
7.............................................................   .796393   .784946   .773641   .762475   .751447
8.............................................................   .770909   .758258   .745790   .733501   .721390
9.............................................................   .746239   .732477   .718941   .705628   .692534
10............................................................   .722360   .707573   .693059   .678814   .664833
11............................................................   .699244   .683516   .668109   .653019   .638239
12............................................................   .676868   .660276   .644057   .628204   .612710
13............................................................   .655209   .637827   .620871   .604332   .588201
14............................................................   .634242   .616141   .598520   .581368   .564673
15............................................................   .613946   .595192   .576973   .559276   .542086
16............................................................   .594300   .574955   .556202   .538023   .520403
17............................................................   .575282   .555407   .536179   .517578   .499587
18............................................................   .556873   .536523   .516876   .497911   .479603
19............................................................   .539053   .518281   .498269   .478990   .460419
20............................................................   .521804   .500660   .480331   .460788   .442002
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  4.2%      4.4%      4.6%      4.8%      5.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .958000   .956000   .954000   .952000   .950000
2.............................................................   .917764   .913936   .910116   .906304   .902500
3.............................................................   .879218   .873723   .868251   .862801   .857375
4.............................................................   .842291   .835279   .828311   .821387   .814506
5.............................................................   .806915   .798527   .790209   .781960   .773781
6.............................................................   .773024   .763392   .753859   .744426   .735092
7.............................................................   .740557   .729802   .719182   .708694   .698337
8.............................................................   .709454   .697691   .686099   .674677   .663420
9.............................................................   .679657   .666993   .654539   .642292   .630249
10............................................................   .651111   .637645   .624430   .611462   .598737
11............................................................   .623764   .609589   .595706   .582112   .568800
12............................................................   .597566   .582767   .568304   .554170   .540360
13............................................................   .572469   .557125   .542162   .527570   .513342
14............................................................   .548425   .532611   .517222   .502247   .487675
15............................................................   .525391   .509177   .493430   .478139   .463291
16............................................................   .503325   .486773   .470732   .455188   .440127
17............................................................   .482185   .465355   .449079   .433339   .418120
18............................................................   .461933   .444879   .428421   .412539   .397214
19............................................................   .442532   .425304   .408714   .392737   .377354
20............................................................   .423946   .406591   .389913   .373886   .358486
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  5.2%      5.4%      5.6%      5.8%      6.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .948000   .946000   .944000   .942000   .940000
2.............................................................   .898704   .894916   .891136   .887364   .883600
3.............................................................   .851971   .846591   .841232   .835897   .830584

[[Page 153]]

                                                                                                                
4.............................................................   .807669   .800875   .794123   .787415   .780749
5.............................................................   .765670   .757627   .749652   .741745   .733904
6.............................................................   .725855   .716716   .707672   .689724   .689870
7.............................................................   .688111   .678013   .668042   .658198   .648478
8.............................................................   .652329   .641400   .630632   .620022   .609569
9.............................................................   .618408   .606765   .595317   .584061   .572995
10............................................................   .586251   .573999   .561979   .550185   .538615
11............................................................   .555766   .543003   .530508   .518275   .506298
12............................................................   .526866   .513681   .500800   .488215   .475920
13............................................................   .499469   .485942   .472755   .459898   .447365
14............................................................   .473496   .459701   .446281   .433224   .420523
15............................................................   .448875   .434878   .421289   .408097   .395292
16............................................................   .425533   .411394   .397697   .384427   .371574
17............................................................   .403405   .389179   .375426   .362131   .349280
18............................................................   .382428   .368163   .354402   .341127   .328323
19............................................................   .362542   .348282   .334555   .321342   .308624
20............................................................   .343690   .329475   .315820   .302704   .290106
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  6.2%      6.4%      6.6%      6.8%      7.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .938000   .936000   .934000   .932000   .930000
2.............................................................   .879844   .876096   .872356   .868624   .864900
3.............................................................   .825294   .820026   .814781   .809558   .804357
4.............................................................   .774125   .767544   .761005   .754508   .748052
5.............................................................   .726130   .718421   .710779   .703201   .695688
6.............................................................   .681110   .672442   .663867   .655383   .646990
7.............................................................   .638881   .629406   .620052   .610817   .601701
8.............................................................   .599270   .589124   .579129   .569282   .559582
9.............................................................   .562115   .551420   .540906   .530571   .520411
10............................................................   .527264   .516129   .505206   .494492   .483982
11............................................................   .494574   .483097   .471863   .460866   .450104
12............................................................   .463910   .452179   .440720   .429527   .418596
13............................................................   .435148   .423239   .411632   .400320   .389295
14............................................................   .408169   .396152   .384465   .373098   .362044
15............................................................   .382862   .370798   .359090   .347727   .336701
16............................................................   .359125   .347067   .335390   .324082   .313132
17............................................................   .336859   .324855   .313254   .302044   .291213
18............................................................   .315974   .304064   .292579   .281505   .270828
19............................................................   .296383   .284604   .273269   .262363   .251870
20............................................................   .278008   .266389   .255233   .244522   .234239
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  7.2%      7.4%      7.6%      7.8%      8.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .928000   .926000   .924000   .922000   .920000
2.............................................................   .861184   .857476   .853776   .850084   .846400
3.............................................................   .799179   .794023   .788889   .783777   .778688
4.............................................................   .741638   .735265   .728933   .722643   .716393
5.............................................................   .688240   .680855   .673535   .666277   .659082
6.............................................................   .638687   .630472   .622346   .614307   .606355
7.............................................................   .592701   .583817   .575048   .566391   .557847
8.............................................................   .550027   .540615   .531344   .522213   .513219
9.............................................................   .510425   .500609   .490962   .481480   .472161
10............................................................   .473674   .463564   .453649   .443925   .434388
11............................................................   .439570   .429260   .419171   .409298   .399637
12............................................................   .407921   .397495   .387314   .377373   .367666
13............................................................   .378550   .368081   .357879   .347938   .338253
14............................................................   .351295   .340843   .330680   .320799   .311193
15............................................................   .326002   .315620   .305548   .295777   .286297
16............................................................   .302529   .292264   .282326   .272706   .263394
17............................................................   .280747   .270637   .260870   .251435   .242322
18............................................................   .260533   .250610   .241044   .231823   .222936
19............................................................   .241775   .232065   .222724   .213741   .205101
20............................................................   .224367   .214892   .205797   .197069   .188693
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  8.2%      8.4%      8.6%      8.8%      9.0%  
----------------------------------------------------------------------------------------------------------------
1.............................................................   .918000   .916000   .914000   .912000   .910000
2.............................................................   .842724   .839056   .835396   .831744   .828100
3.............................................................   .773621   .768575   .763552   .758551   .753571
4.............................................................   .710184   .704015   .697886   .691798   .685750
5.............................................................   .651949   .644878   .637868   .630920   .624032
6.............................................................   .598489   .590708   .583012   .575399   .567869
7.............................................................   .549413   .541089   .532873   .524764   .516761
8.............................................................   .504361   .495637   .487046   .478585   .470253
9.............................................................   .463003   .454004   .445160   .436469   .427930
10............................................................   .425037   .415867   .406876   .398060   .389416
11............................................................   .390184   .380934   .371885   .363031   .354369
12............................................................   .358189   .348936   .339902   .331084   .322475
13............................................................   .328817   .319625   .310671   .301949   .293453
14............................................................   .301854   .292777   .283953   .275377   .267042
15............................................................   .277102   .268184   .259533   .251144   .243008
16............................................................   .254380   .245656   .237213   .229043   .221137
17............................................................   .233521   .225021   .216813   .208887   .201235
18............................................................   .214372   .206119   .198167   .190505   .183124
19............................................................   .196794   .188805   .181125   .173741   .166643
20............................................................   .180657   .172946   .165548   .158452   .151645
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  9.2%      9.4%      9.6%      9.8$      10.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .908000   .906000   .904000   .902000   .900000

[[Page 154]]

                                                                                                                
2.............................................................   .824464   .820836   .817216   .813604   .810000
3.............................................................   .748613   .743677   .738763   .733871   .729000
4.............................................................   .679741   .673772   .667842   .661951   .656100
5.............................................................   .617205   .610437   .603729   .597080   .590490
6.............................................................   .560422   .553056   .545771   .538566   .531441
7.............................................................   .508863   .501069   .493377   .485787   .478297
8.............................................................   .462048   .453968   .446013   .438180   .430467
9.............................................................   .419539   .411295   .403196   .395238   .387420
10............................................................   .380942   .372634   .364489   .356505   .348678
11............................................................   .345895   .337606   .329498   .321567   .313811
12............................................................   .314073   .305871   .297866   .290054   .282430
13............................................................   .285178   .277119   .269271   .261628   .254187
14............................................................   .258942   .251070   .243421   .235989   .228768
15............................................................   .235119   .227469   .220053   .212862   .205891
16............................................................   .213488   .206087   .198928   .192001   .185302
17............................................................   .193847   .186715   .179830   .173185   .166772
18............................................................   .176013   .169164   .162567   .156213   .150095
19............................................................   .159820   .153262   .146960   .140904   .135085
20............................................................   .145117   .138856   .132852   .127096   .121577
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  10.2%     10.4%     10.6%     10.8%     11.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .898000   .896000   .894000   .892000   .890000
2.............................................................   .806404   .802816   .799236   .795664   .792100
3.............................................................   .724151   .719323   .714517   .709732   .704969
4.............................................................   .650287   .644514   .638778   .633081   .627422
5.............................................................   .583958   .577484   .571068   .564708   .558406
6.............................................................   .524394   .517426   .510535   .503720   .496981
7.............................................................   .470906   .463613   .456418   .448318   .442313
8.............................................................   .422874   .415398   .408038   .400792   .393659
9.............................................................   .379741   .372196   .364786   .357506   .350356
10............................................................   .341007   .333488   .326118   .318896   .311817
11............................................................   .306224   .298805   .291550   .284455   .277517
12............................................................   .274989   .267729   .260645   .253734   .246990
13............................................................   .246941   .239886   .233017   .226331   .219821
14............................................................   .221753   .214937   .208317   .201887   .195641
15............................................................   .199134   .192584   .186236   .180083   .174121
16............................................................   .178822   .172555   .166495   .160634   .154967
17............................................................   .160582   .154609   .148846   .143286   .137921
18............................................................   .144203   .138530   .133069   .127811   .122750
19............................................................   .129494   .124123   .118963   .114007   .109247
20............................................................   .116286   .111214   .106353   .101694   .097230
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  11.2%     11.4%     11.6%     11.8%     12.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .888000   .886000   .884000   .882000   .880000
2.............................................................   .788544   .784996   .781456   .777924   .774400
3.............................................................   .700227   .695506   .690807   .686129   .681472
4.............................................................   .621802   .616219   .610673   .605166   .599695
5.............................................................   .552160   .545970   .539835   .533756   .527732
6.............................................................   .490318   .483729   .477214   .470773   .464404
7.............................................................   .435402   .428584   .421858   .415222   .408676
8.............................................................   .386637   .379726   .372922   .366226   .359635
9.............................................................   .343334   .336437   .329663   .323011   .316478
10............................................................   .304881   .298083   .291422   .284896   .278501
11............................................................   .270734   .264102   .257617   .251278   .245081
12............................................................   .240412   .233994   .227734   .221627   .215671
13............................................................   .213486   .207319   .201317   .195475   .189791
14............................................................   .189575   .183684   .177964   .172409   .167016
15............................................................   .168343   .162744   .157320   .152065   .146974
16............................................................   .149488   .144191   .139071   .134121   .129337
17............................................................   .132746   .127754   .122939   .118295   .113817
18............................................................   .117878   .113190   .108678   .104336   .100159
19............................................................   .104676   .100286   .096071   .092024   .088140
20............................................................   .092952   .088853   .084927   .081166   .077563
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  12.2%     12.4%     12.6%     12.8%     13.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .878000   .876000   .874000   .872000   .870000
2.............................................................   .770884   .767376   .763876   .760384   .756900
3.............................................................   .676836   .672221   .667628   .663055   .658503
4.............................................................   .594262   .588866   .583507   .578184   .572898
5.............................................................   .521762   .515847   .509985   .504176   .498421
6.............................................................   .458107   .451882   .445727   .439642   .433626
7.............................................................   .402218   .395848   .389565   .383368   .377255
8.............................................................   .353147   .346763   .340480   .334297   .328212
9.............................................................   .310063   .303764   .297579   .291507   .285544
10............................................................   .272236   .266098   .260084   .254194   .248423
11............................................................   .239023   .233102   .227314   .221657   .216128
12............................................................   .209862   .204197   .198672   .193285   .188032
13............................................................   .184259   .178877   .173640   .168544   .163588
14............................................................   .161779   .156696   .151761   .146971   .142321
15............................................................   .142042   .137266   .132639   .128158   .123819
16............................................................   .124713   .120245   .115927   .111754   .107723
17............................................................   .109498   .105334   .101320   .097450   .093719
18............................................................   .096139   .092273   .088554   .084976   .081535
19............................................................   .084410   .080831   .077396   .074099   .070936
20............................................................   .074112   .070808   .067644   .064614   .061714
----------------------------------------------------------------------------------------------------------------


[[Page 155]]


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  13.2%     13.4%     13.6%     13.8%     14.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .868000   .866000   .864000   .862000   .860000
2.............................................................   .753424   .749956   .746496   .743044   .739600
3.............................................................   .653972   .649462   .644973   .640504   .636056
4.............................................................   .567648   .562434   .557256   .552114   .547008
5.............................................................   .492718   .487068   .481469   .475923   .470427
6.............................................................   .427679   .421801   .415990   .410245   .404567
7.............................................................   .371226   .365279   .359415   .353631   .347928
8.............................................................   .322224   .316332   .310535   .304830   .299218
9.............................................................   .279690   .274944   .268302   .262764   .257327
10............................................................   .242771   .237235   .231813   .226502   .221302
11............................................................   .210725   .205446   .200286   .195245   .190319
12............................................................   .182910   .177916   .173047   .168301   .163675
13............................................................   .158766   .154075   .149513   .145076   .140760
14............................................................   .137809   .133429   .129179   .125055   .121054
15............................................................   .119618   .115550   .111611   .107798   .104106
16............................................................   .103828   .100066   .096432   .092922   .089531
17............................................................   .090123   .086657   .083317   .080098   .076997
18............................................................   .078227   .075045   .071986   .069045   .066217
19............................................................   .067901   .064989   .062196   .059517   .056947
20............................................................   .058938   .056280   .053737   .051303   .048974
----------------------------------------------------------------------------------------------------------------


                                                     Table D                                                    
 Table D--Term Certain--Table Showing the Present Worth of a Remainder Interest Postponed for a Term of Years in
 a Charitable Remainder Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 
                                        30, 1983, and Before May 1, 1989                                        
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  14.2%     14.4%     14.6%     14.8%     15.0% 
----------------------------------------------------------------------------------------------------------------
1.............................................................   .858000   .856000   .854000   .852000   .850000
2.............................................................   .736164   .732736   .729316   .725904   .722500
3.............................................................   .631629   .627222   .622836   .618470   .614125
4.............................................................   .541937   .536902   .531902   .526937   .522006
5.............................................................   .464982   .459588   .454244   .448950   .443705
6.............................................................   .398955   .393407   .387925   .382505   .377150
7.............................................................   .342303   .336757   .331288   .325895   .320577
8.............................................................   .293696   .288264   .282920   .277662   .274291
9.............................................................   .251991   .246754   .241613   .236568   .231617
10............................................................   .216209   .211221   .206338   .201556   .196874
11............................................................   .185507   .180805   .176212   .171726   .167343
12............................................................   .159165   .154769   .150485   .146310   .142242
13............................................................   .136564   .132483   .128515   .124656   .120905
14............................................................   .117172   .113405   .109751   .106207   .102770
15............................................................   .100533   .097075   .093728   .090489   .087354
16............................................................   .086257   .083096   .080043   .077096   .074251
17............................................................   .074009   .071130   .068357   .065686   .063113
18............................................................   .063500   .060887   .058377   .055965   .053646
19............................................................   .054483   .052120   .049854   .047682   .045599
20............................................................   .046746   .044614   .042575   .040625   .038760
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  2.2%      2.4%      2.6%      2.8%      3.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .23253    .20635    .18364    .16394    .14683
1.............................................................    .22196    .19506    .17170    .15139    .13372
2.............................................................    .22597    .19884    .17523    .15468    .13676
3.............................................................    .23039    .20304    .17920    .15840    .14024
4.............................................................    .23503    .20747    .18340    .16237    .14397
5.............................................................    .23988    .21211    .18783    .16656    .14793
6.............................................................    .24489    .21693    .19243    .17094    .15207
7.............................................................    .25004    .22189    .19718    .17546    .15637
8.............................................................    .25534    .22701    .20209    .18016    .16084
9.............................................................    .26080    .23230    .20718    .18503    .16549
10............................................................    .26640    .23774    .21243    .19008    .17031
11............................................................    .27217    .24335    .21786    .19530    .17532
12............................................................    .27807    .24911    .22344    .20068    .18049
13............................................................    .28407    .25497    .22913    .20618    .18579
14............................................................    .29013    .26089    .23489    .21175    .19115
15............................................................    .29621    .26684    .24067    .21735    .19655
16............................................................    .30229    .27279    .24647    .22296    .20196
17............................................................    .30838    .27876    .25228    .22859    .20739
18............................................................    .31451    .28477    .25813    .23427    .21287
19............................................................    .32070    .29085    .26407    .24003    .21844
20............................................................    .32699    .29704    .27012    .24591    .22413
21............................................................    .33339    .30335    .27629    .25192    .22996
22............................................................    .33991    .30977    .28259    .25807    .23592
23............................................................    .34655    .31634    .28904    .26437    .24205
24............................................................    .35334    .32306    .29566    .27085    .24836
25............................................................    .36031    .32998    .30248    .27754    .25490
26............................................................    .36746    .33710    .30952    .28446    .26167
27............................................................    .37481    .34443    .31678    .29161    .26869
28............................................................    .38236    .35197    .32427    .29901    .27596
29............................................................    .39006    .35968    .33194    .30660    .28344
30............................................................    .39793    .36757    .33980    .31439    .29113
31............................................................    .40594    .37561    .34783    .32237    .29902
32............................................................    .41410    .38383    .35605    .33054    .30711
33............................................................    .42240    .39220    .36444    .33890    .31541
34............................................................    .43084    .40072    .37299    .34744    .32389
35............................................................    .43942    .40941    .38172    .35617    .33258
36............................................................    .44813    .41824    .39061    .36508    .34146
37............................................................    .45696    .42720    .39966    .37416    .35053
38............................................................    .46591    .43630    .40885    .38339    .35977
39............................................................    .47496    .44552    .41818    .39278    .36917
40............................................................    .48412    .45486    .42765    .40232    .37875
41............................................................    .49338    .46432    .43725    .41201    .38849
42............................................................    .50275    .47391    .44700    .42187    .39840
43............................................................    .51221    .48360    .45686    .43186    .40847
44............................................................    .52175    .49340    .46685    .44199    .41870
45............................................................    .53136    .50327    .47693    .45223    .42905
46............................................................    .54104    .51323    .48712    .46259    .43953
47............................................................    .55077    .52327    .49739    .47305    .45013
48............................................................    .56058    .53339    .50777    .48363    .46087
49............................................................    .57043    .54358    .51823    .49432    .47173
50............................................................    .58035    .55384    .52879    .50510    .48271
51............................................................    .59029    .56415    .53940    .51597    .49379
52............................................................    .60027    .57450    .55008    .52692    .50496
53............................................................    .61026    .58488    .56080    .53793    .51620
54............................................................    .62025    .59528    .57154    .54897    .52750
55............................................................    .63022    .60567    .58230    .56004    .53884
56............................................................    .64018    .61606    .59306    .57113    .55021
57............................................................    .65012    .62644    .60384    .58225    .56163
58............................................................    .66004    .63681    .61461    .59337    .57306
59............................................................    .66993    .64717    .62538    .60452    .58453
60............................................................    .67979    .65751    .63615    .61567    .59602
61............................................................    .68963    .66784    .64692    .62683    .60754
62............................................................    .69944    .67815    .65769    .63801    .61908
63............................................................    .70922    .68844    .66843    .64918    .63063
64............................................................    .71893    .69868    .67915    .66032    .64217
65............................................................    .72859    .70886    .68982    .67144    .65369

[[Page 156]]

                                                                                                                
66............................................................    .73817    .71897    .70043    .68250    .66517
67............................................................    .74766    .72901    .71096    .69350    .67660
68............................................................    .75706    .73896    .72142    .70443    .68796
69............................................................    .76637    .74882    .73181    .71530    .69928
70............................................................    .77559    .75861    .74212    .72610    .71053
71............................................................    .78475    .76833    .75237   1.73685   1.72176
72............................................................    .79383    .77799    .76257    .74756    .73294
73............................................................    .80279    .78753    .77266    .75816    .74403
74............................................................    .81158    .79689    .78256    .76858    .75494
75............................................................    .82013    .80602    .79223    .77876    .76561
76............................................................    .82844    .81488    .80163    .78867    .77599
77............................................................    .83648    .82347    .81075    .79829    .78609
78............................................................    .84428    .83182    .81961    .80764    .79592
79............................................................    .85187    .83994    .82824    .81677    .80552
80............................................................    .85927    .84787    .83668    .82569    .81491
81............................................................    .86645    .85556    .84487    .83437    .82404
82............................................................    .87336    .86299    .85278    .84275    .83288
83............................................................    .88003    .87014    .86042    .85084    .84142
84............................................................    .88648    .87708    .86782    .85870    .84971
85............................................................    .89273    .88381    .87501    .86633    .85778
86............................................................    .89868    .89021    .88185    .87360    .86547
87............................................................    .90417    .89613    .88818    .88034    .87260
88............................................................    .90923    .90158    .89402    .88655    .87917
89............................................................    .91396    .90668    .89948    .89237    .88533
90............................................................    .91849    .91156    .90471    .89794    .89124
91............................................................    .92278    .91620    .90968    .90324    .89686
92............................................................    .92673    .92046    .91426    .90812    .90204
93............................................................    .93027    .92429    .91837    .91251    .90670
94............................................................    .93341    .92768    .92201    .91639    .91082
95............................................................    .93612    .93062    .92516    .91976    .91440
96............................................................    .93841    .93309    .92782    .92259    .91740
97............................................................    .94044    .93529    .93018    .92512    .92009
98............................................................    .94223    .93723    .93226    .92733    .92244
99............................................................    .94392    .93905    .93421    .92942    .92466
100...........................................................    .94559    .94086    .93615    .93149    .92685
101...........................................................    .94709    .94248    .93790    .93334    .92882
102...........................................................    .94873    .94424    .93979    .93536    .93096
103...........................................................    .95077    .94645    .94216    .93789    .93365
104...........................................................    .95278    .94862    .94449    .94037    .93628
105...........................................................    .95570    .95178    .94787    .94399    .94012
106...........................................................    .96017    .95662    .95309    .94957    .94607
107...........................................................    .96616    .96313    .96010    .95709    .95408
108...........................................................    .97515    .97291    .97067    .96843    .96620
109...........................................................    .98900    .98800    .98700    .98600    .98500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                           (1) Years                           -------------------------------------------------
                                                                  3.2%      3.4%      3.6%      3.8%      4.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .13196    .11901    .10774    .09791    .08933
1.............................................................    .11834    .10493    .09324    .08303    .07410
2.............................................................    .12113    .10749    .09557    .08514    .07601
3.............................................................    .12437    .11050    .09835    .08770    .07837
4.............................................................    .12787    .11376    .10138    .09052    .08098
5.............................................................    .13159    .11725    .10465    .09357    .08382
6.............................................................    .13549    .12092    .10810    .09680    .08684
7.............................................................    .13956    .12476    .11171    .10019    .09002
8.............................................................    .14380    .12877    .11549    .10376    .09337
9.............................................................    .14822    .13296    .11946    .10751    .09691
10............................................................    .15282    .13734    .12361    .11144    .10063
11............................................................    .15761    .14190    .12795    .11556    .10454
12............................................................    .16257    .14663    .13247    .11986    .10863
13............................................................    .16764    .15149    .13711    .12428    .12283
14............................................................    .17279    .15643    .14182    .12878    .11712
15............................................................    .17798    .16140    .14657    .13331    .12143
16............................................................    .18318    .16638    .15133    .13785    .12576
17............................................................    .18840    .17138    .15611    .14241    .13010
18............................................................    .19367    .17643    .16094    .14702    .13449
19............................................................    .19903    .18157    .16586    .15172    .13897
20............................................................    .20452    .18685    .17092    .15655    .14358
21............................................................    .21014    .19226    .17612    .16153    .14833
22............................................................    .21591    .19783    .18146    .16665    .15324
23............................................................    .22185    .20356    .18698    .17195    .15832
24............................................................    .22798    .20949    .19270    .17746    .16361
25............................................................    .23434    .21565    .19866    .18321    .16914
26............................................................    .24094    .22207    .20489    .18922    .17494
27............................................................    .24780    .22875    .21138    .19551    .18102
28............................................................    .25492    .23570    .21814    .20208    .18739
29............................................................    .26226    .24288    .22514    .20889    .19400
30............................................................    .26982    .25029    .23239    .21596    .20088
31............................................................    .27759    .25792    .23985    .22324    .20798
32............................................................    .28557    .26577    .24755    .23078    .21533
33............................................................    .29377    .27385    .25548    .23855    .22293
34............................................................    .30217    .28214    .26364    .24656    .23077
35............................................................    .31079    .29065    .27203    .25481    .23887
36............................................................    .31961    .29939    .28065    .26330    .24721
37............................................................    .32863    .30833    .28950    .27202    .25579
38............................................................    .33784    .31747    .29855    .28096    .26460
39............................................................    .34722    .32680    .30780    .29011    .27363
40............................................................    .35679    .33633    .31727    .29948    .28290
41............................................................    .36654    .34606    .32693    .30908    .29239
42............................................................    .37648    .35599    .33683    .31890    .30213
43............................................................    .38659    .36610    .34691    .32894    .31209
44............................................................    .39687    .37640    .35720    .33918    .32227
45............................................................    .40728    .38685    .36765    .34961    .33265
46............................................................    .41785    .39746    .37828    .36023    .34323
47............................................................    .42856    .40823    .38908    .37103    .35400
48............................................................    .43941    .41917    .40006    .38202    .36499
49............................................................    .45040    .43025    .41121    .39320    .37617
50............................................................    .46153    .44149    .42252    .40457    .38756
51............................................................    .47277    .45286    .43398    .41609    .39911
52............................................................    .48412    .46435    .44558    .42776    .41084
53............................................................    .49556    .47595    .45731    .43958    .42272
54............................................................    .50707    .48763    .46913    .45151    .43473
55............................................................    .51864    .49939    .48104    .46354    .44685
56............................................................    .53026    .51121    .49303    .47567    .45908
57............................................................    .54192    .52310    .50510    .48789    .47143
58............................................................    .55363    .53503    .51723    .50019    .48387
59............................................................    .56538    .54703    .52945    .51258    .49642
60............................................................    .57717    .55909    .54173    .52506    .50906
61............................................................    .58901    .57120    .55408    .53763    .52181
62............................................................    .60087    .58336    .56650    .55028    .53466
63............................................................    .61277    .59556    .57898    .56300    .54760
64............................................................    .62467    .60778    .59149    .57577    .56060
65............................................................    .63655    .62000    .60402    .58857    .57365
66............................................................    .64842    .63221    .61654    .60139    .58672
67............................................................    .66023    .64439    .62905    .61420    .59980
68............................................................    .67200    .65653    .64154    .62699    .61289
69............................................................    .68373    .66865    .65400    .63978    .62598
70............................................................    .69541    .68072    .66645    .65257    .63908
71............................................................    .70708    .69279    .67890    .66538    .65222
72............................................................    .71870    .70484    .69134    .67819    .66538
73............................................................    .73025    .71682    .70372    .69095    .67850
74............................................................    .74163    .72863    .71595    .70356    .69147

[[Page 157]]

                                                                                                                
75............................................................    .75275    .74019    .72792    .71593    .70421
76............................................................    .76360    .75147    .73962    .72802    .71667
77............................................................    .77415    .76246    .75102    .73981    .72883
78............................................................    .78443    .77318    .76214    .75133    .74073
79............................................................    .79448    .78365    .77303    .76261    .75238
80............................................................    .80432    .79392    .78371    .77369    .76384
81............................................................    .81390    .80393    .79413    .78450    .77504
82............................................................    .82317    .81362    .80423    .79499    .78590
83............................................................    .83214    .82301    .81402    .80517    .79645
84............................................................    .84086    .83214    .82355    .81508    .80674
85............................................................    .84935    .84104    .83284    .82476    .81679
86............................................................    .85745    .84953    .84172    .83401    .82640
87............................................................    .86496    .85741    .84996    .84260    .83533
88............................................................    .87189    .86468    .85757    .85054    .84359
89............................................................    .87838    .87150    .86471    .85799    .85135
90............................................................    .88461    .87806    .87157    .86516    .85881
91............................................................    .89055    .88430    .87812    .87200    .86594
92............................................................    .89602    .89006    .88416    .87831    .87252
93............................................................    .90094    .89524    .88959    .88400    .87846
94............................................................    .90530    .89983    .89441    .88904    .88372
95............................................................    .90908    .90381    .89359    .89341    .88828
96............................................................    .91226    .90716    .90211    .89709    .89212
97............................................................    .91510    .91015    .90525    .90038    .89555
98............................................................    .91759    .91277    .90800    .90326    .89855
99............................................................    .91993    .91524    .91058    .90596    .90137
100...........................................................    .92225    .91768    .91315    .90865    .90417
101...........................................................    .92433    .91987    .91544    .91104    .90667
102...........................................................    .92659    .92225    .91793    .91364    .90938
103...........................................................    .92943    .92524    .92107    .91692    .91280
104...........................................................    .93221    .92816    .92413    .92012    .91614
105...........................................................    .93627    .93244    .92863    .92483    .92105
106...........................................................    .94257    .93909    .93562    .93217    .92872
107...........................................................    .95107    .94808    .94509    .94211    .93914
108...........................................................    .96396    .96173    .95950    .95728    .95505
109...........................................................    .98400    .98300    .98200    .98100    .98000
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  4.2%      4.4%      4.6%      4.8%      5.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .08183    .07527    .06952    .06448    .06005
1.............................................................    .06629    .05945    .05344    .04817    .04354
2.............................................................    .06801    .06098    .05481    .04939    .04460
3.............................................................    .07017    .06297    .05663    .05104    .04611
4.............................................................    .07259    .06520    .05868    .05294    .04786
5.............................................................    .07523    .06765    .06096    .05505    .04982
6.............................................................    .07805    .07029    .06342    .05734    .05195
7.............................................................    .08103    .07307    .06603    .05978    .05423
8.............................................................    .08418    .07603    .06880    .06238    .05666
9.............................................................    .08752    .07917    .07175    .06516    .05928
10............................................................    .09103    .08249    .07488    .06811    .06206
11............................................................    .09473    .08600    .07820    .07125    .06503
12............................................................    .09861    .08968    .08169    .07456    .06817
13............................................................    .10261    .09348    .08530    .07799    .07142
14............................................................    .10669    .09735    .08899    .08148    .07474
15............................................................    .11080    .10126    .09269    .08500    .07808
16............................................................    .11491    .10516    .09640    .08852    .08142
17............................................................    .11903    .10908    .10012    .09204    .08475
18............................................................    .12321    .11304    .10387    .09560    .08812
19............................................................    .12747    .11709    .10771    .09923    .09156
20............................................................    .13186    .12126    .11168    .10300    .09513
21............................................................    .13639    .12558    .11578    .10690    .09883
22............................................................    .14108    .13005    .12004    .11094    .10268
23............................................................    .14594    .13469    .12446    .11516    .10669
24............................................................    .15101    .13954    .12910    .11958    .11091
25............................................................    .15632    .14464    .13398    .12426    .11537
26............................................................    .16191    .15001    .13914    .12920    .12011
27............................................................    .16778    .15567    .14459    .13444    .12514
28............................................................    .17394    .16162    .15032    .13997    .13046
29............................................................    .18035    .16782    .15632    .14575    .13604
30............................................................    .18702    .17429    .16259    .15181    .14189
31............................................................    .19393    .18100    .16909    .15811    .14799
32............................................................    .20109    .18797    .17586    .16468    .15436
33............................................................    .20851    .19520    .18290    .17152    .16100
34............................................................    .21618    .20268    .19018    .17861    .16789
35............................................................    .22411    .21043    .19775    .18599    .17508
36............................................................    .23228    .21844    .20558    .19363    .18253
37............................................................    .24071    .22670    .21367    .20154    .19026
38............................................................    .24938    .23521    .22201    .20971    .19825
39............................................................    .25827    .24396    .23060    .21814    .20650
40............................................................    .26741    .25295    .23945    .22682    .21502
41............................................................    .27679    .26220    .24855    .23577    .22381
42............................................................    .28642    .27172    .25793    .24501    .23289
43............................................................    .29629    .28147    .26756    .25450    .24224
44............................................................    .30639    .29147    .27745    .26426    .25186
45............................................................    .31669    .30169    .28756    .27426    .26173
46............................................................    .32722    .31213    .29791    .28450    .27185
47............................................................    .33795    .32280    .30849    .29498    .28222
48............................................................    .34890    .33370    .31932    .30573    .29287
49............................................................    .36007    .34482    .33039    .31672    .30377
50............................................................    .37144    .35617    .34170    .32797    .31494
51............................................................    .38301    .36773    .35322    .33944    .32635
52............................................................    .39476    .37948    .36495    .35113    .33799
53............................................................    .40668    .39141    .37688    .36304    .34986
54............................................................    .41874    .40350    .38897    .37512    .36191
55............................................................    .43093    .41574    .40123    .38739    .37416
56............................................................    .44324    .42811    .41364    .39980    .38657
57............................................................    .45568    .44062    .42620    .41240    .39918
58............................................................    .46823    .45325    .43890    .42514    .41194
59............................................................    .48091    .46603    .45175    .43805    .42489
60............................................................    .49370    .47893    .46475    .45112    .43802
61............................................................    .50661    .49198    .47790    .46436    .45133
62............................................................    .51963    .50515    .49120    .47776    .46481
63............................................................    .53275    .51844    .50463    .49131    .47846
64............................................................    .54596    .53182    .51817    .50498    .49225
65............................................................    .55922    .54528    .53180    .51877    .50616
66............................................................    .57253    .55880    .54551    .53264    .52018
67............................................................    .58586    .57235    .55926    .54657    .53427
68............................................................    .59921    .58594    .57306    .56057    .54845
69............................................................    .61258    .59956    .58692    .57463    .56270
70............................................................    .62597    .61322    .60082    .58877    .57704
71............................................................    .63941    .62695    .61481    .60300    .59149
72............................................................    .65289    .64073    .62887    .61731    .60605
73............................................................    .66635    .65449    .64293    .63165    .62064
74............................................................    .67976    .66814    .65688    .64588    .63514
75............................................................    .69275    .68156    .67061    .65990    .64944
76............................................................    .70557    .69470    .68407    .67366    .66348
77............................................................    .71809    .70756    .69724    .68714    .67724
78............................................................    .73033    .72014    .71015    .70036    .69075
79............................................................    .74235    .73251    .72284    .71336    .70405
80............................................................    .75417    .74468    .73535    .72619    .71718
81............................................................    .76573    .75659    .74759    .73875    .73006
82............................................................    .77696    .76816    .75951    .75099    .74261
83............................................................    .78787    .77942    .77110    .76291    .75484

[[Page 158]]

                                                                                                                
84............................................................    .79852    .79042    .78243    .77457    .76681
85............................................................    .80893    .80118    .79353    .78599    .77856
86............................................................    .81889    .81148    .80417    .79695    .78983
87............................................................    .82816    .82107    .81408    .80716    .80034
88............................................................    .83673    .82994    .82324    .81662    .81007
89............................................................    .84478    .83828    .83186    .82551    .81923
90............................................................    .85253    .84632    .84018    .83410    .82808
91............................................................    .85994    .85401    .84813    .84232    .83656
92............................................................    .86679    .86111    .85549    .84993    .84441
93............................................................    .87296    .86752    .86213    .85679    .85150
94............................................................    .87844    .87321    .86803    .86289    .85780
95............................................................    .88319    .87815    .87314    .86818    .86327
96............................................................    .88719    .88230    .87745    .87264    .86787
97............................................................    .89076    .88601    .88129    .87661    .87197
98............................................................    .89388    .88925    .88465    .88009    .87556
99............................................................    .89682    .89230    .88781    .88336    .87894
100...........................................................    .89973    .89533    .89095    .88660    .88228
101...........................................................    .90233    .89802    .89374    .88948    .88526
102...........................................................    .90515    .90094    .89676    .89260    .88848
103...........................................................    .90871    .90464    .90059    .89656    .89256
104...........................................................    .91217    .90823    .90431    .90040    .89652
105...........................................................    .91729    .91354    .90981    .90610    .90240
106...........................................................    .92529    .92187    .91846    .91507    .91169
107...........................................................    .93617    .93322    .93027    .92732    .92439
108...........................................................    .95283    .95062    .94840    .94619    .94398
109...........................................................    .97900    .97800    .97700    .97600    .97500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  5.2%      5.4%      5.6%      5.8%      6.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .05615    .05272    .04969    .04701    .04464
1.............................................................    .03945    .03585    .03268    .02986    .02737
2.............................................................    .04039    .03667    .03337    .03046    .02787
3.............................................................    .04176    .03791    .03450    .03147    .02879
4.............................................................    .04336    .03938    .03585    .03272    .02993
5.............................................................    .04518    .04107    .03741    .03416    .03127
6.............................................................    .04717    .04292    .03914    .03577    .03276
7.............................................................    .04929    .04490    .04099    .03750    .03438
8.............................................................    .05158    .04704    .04300    .03938    .03615
9.............................................................    .05404    .04936    .04518    .04143    .03808
10............................................................    .05666    .05183    .04751    .04364    .04016
11............................................................    .05947    .05449    .05003    .04602    .04242
12............................................................    .06245    .05731    .05271    .04856    .04484
13............................................................    .06554    .06025    .05549    .05121    .04735
14............................................................    .06869    .06324    .05834    .05391    .04992
15............................................................    .07186    .06625    .06119    .05662    .05250
16............................................................    .07502    .06924    .06403    .05931    .05504
17............................................................    .07817    .07223    .06685    .06199    .05757
18............................................................    .08136    .07524    .06970    .06468    .06012
19............................................................    .08462    .07832    .07261    .06743    .06272
20............................................................    .08800    .08152    .07564    .07029    .06542
21............................................................    .09151    .08485    .07879    .07327    .06824
22............................................................    .09516    .08831    .08207    .07638    .07119
23............................................................    .09897    .09193    .08551    .07964    .07428
24............................................................    .10299    .09576    .08915    .08310    .07756
25............................................................    .10725    .09982    .09302    .08679    .08108
26............................................................    .11179    .10416    .09717    .09075    .08486
27............................................................    .11661    .10878    .10160    .09500    .08892
28............................................................    .12173    .11370    .10632    .09953    .09328
29............................................................    .12710    .11888    .11130    .10432    .09788
30............................................................    .13276    .12433    .11656    .10938    .10276
31............................................................    .13865    .13002    .12205    .11469    .10787
32............................................................    .14482    .13599    .12783    .12026    .11326
33............................................................    .15126    .14223    .13387    .12612    .11892
34............................................................    .15796    .14874    .14018    .13223    .12485
35............................................................    .16494    .15553    .14678    .13864    .13107
36............................................................    .17221    .16260    .15366    .14533    .13757
37............................................................    .17975    .16996    .16082    .15231    .14435
38............................................................    .18756    .17758    .16826    .15955    .15142
39............................................................    .19563    .18547    .17597    .16708    .15875
40............................................................    .20397    .19364    .18395    .17488    .16638
41............................................................    .21259    .20209    .19223    .18298    .17430
42............................................................    .22152    .21084    .20082    .19140    .18254
43............................................................    .23071    .21988    .20969    .20010    .19107
44............................................................    .24019    .22920    .21885    .20910    .19991
45............................................................    .24992    .23878    .22828    .21837    .20902
46............................................................    .25991    .24864    .23799    .22793    .21842
47............................................................    .27016    .25876    .24798    .23777    .22812
48............................................................    .28070    .26918    .25826    .24792    .23812
49............................................................    .29150    .27987    .26883    .25837    .24843
50............................................................    .30258    .29084    .27970    .26911    .25905
51............................................................    .31391    .30208    .29084    .28014    .26996
52............................................................    .32548    .31358    .30224    .29144    .28115
53............................................................    .33729    .32532    .31390    .30302    .29263
54............................................................    .34931    .33728    .32579    .31482    .30434
55............................................................    .36152    .34945    .33790    .32686    .31631
56............................................................    .37392    .36181    .35022    .33912    .32850
57............................................................    .38652    .37438    .36276    .35162    .34093
58............................................................    .39929    .38715    .37550    .36432    .35359
59............................................................    .41226    .40013    .38847    .37727    .36650
60............................................................    .42542    .41331    .40165    .39044    .37965
61............................................................    .43878    .42670    .41506    .40386    .39306
62............................................................    .45233    .44029    .42869    .41750    .40671
63............................................................    .46606    .45409    .44253    .43138    .42060
64............................................................    .47994    .46805    .45656    .44545    .43471
65............................................................    .49397    .48217    .47076    .45971    .44902
66............................................................    .50811    .49642    .48510    .47413    .46350
67............................................................    .52235    .51079    .49957    .48869    .47814
68............................................................    .53668    .52525    .51416    .50339    .49293
69............................................................    .55110    .53983    .52888    .51823    .50788
70............................................................    .56563    .55453    .54373    .53322    .52299
71............................................................    .58029    .56938    .55875    .54839    .53830
72............................................................    .59507    .58436    .57392    .56374    .55380
73............................................................    .60990    .59941    .58917    .57918    .56942
74............................................................    .62465    .61439    .60437    .59458    .58502
75............................................................    .63920    .62919    .61940    .60983    .60046
76............................................................    .65351    .64375    .63419    .62484    .61568
77............................................................    .66755    .65804    .64873    .63961    .63066
78............................................................    .68133    .67209    .66303    .65414    .64542
79............................................................    .69492    .68595    .67714    .66850    .66001
80............................................................    .70834    .69965    .69111    .68272    .67448
81............................................................    .72151    .71311    .70484    .69671    .68872
82............................................................    .73436    .72624    .71825    .71039    .70265
83............................................................    .74689    .73906    .73135    .72376    .71627
84............................................................    .75917    .75163    .74421    .73688    .72967
85............................................................    .77122    .76398    .75685    .74980    .74286
86............................................................    .78280    .77586    .76901    .76224    .75556
87............................................................    .79359    .78693    .78036    .77386    .76744
88............................................................    .80360    .79720    .79088    .78463    .77846
89............................................................    .81302    .80688    .80081    .79480    .78886
90............................................................    .82213    .81624    .81041    .80465    .79894
91............................................................    .83086    .82522    .81963    .81410    .80862
92............................................................    .83895    .83354    .82818    .82287    .81762

[[Page 159]]

                                                                                                                
93............................................................    .84626    .84106    .83591    .83081    .82575
94............................................................    .85275    .84774    .84278    .83787    .83299
95............................................................    .85839    .85355    .84876    .84400    .83929
96............................................................    .86313    .85844    .85378    .84916    .84458
97............................................................    .86737    .86280    .85826    .85377    .84930
98............................................................    .87107    .86661    .86218    .85779    .85343
99............................................................    .87455    .87019    .86586    .86157    .85730
100...........................................................    .87800    .87374    .86951    .86532    .86115
101...........................................................    .88106    .87689    .87275    .86863    .86455
102...........................................................    .88437    .88030    .87625    .87222    .86822
103...........................................................    .88858    .88463    .88070    .87679    .87290
104...........................................................    .89266    .88882    .88500    .88120    .87741
105...........................................................    .89872    .89506    .89141    .88778    .88417
106...........................................................    .90832    .90496    .90161    .89828    .89496
107...........................................................    .92146    .91854    .91562    .91271    .90981
108...........................................................    .94177    .93956    .93736    .93516    .93296
109...........................................................    .97400    .97300    .97200    .97100    .97000
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted Payout Rate            
                            (1) Age                            -------------------------------------------------
                                                                  6.2%      6.4%      6.6%      6.8%      7.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .04253    .04066    .03899    .03751    .03618
1.............................................................    .02516    .02320    .02145    .01989    .01850
2.............................................................    .02557    .02353    .02171    .02008    .01862
3.............................................................    .02640    .02427    .02237    .02067    .01915
4.............................................................    .02744    .02523    .02325    .02147    .01988
5.............................................................    .02868    .02638    .02431    .02246    .02080
6.............................................................    .03008    .02767    .02552    .02359    .02185
7.............................................................    .03159    .02909    .02685    .02483    .02302
8.............................................................    .03325    .03065    .02831    .02621    .02432
9.............................................................    .03507    .03236    .02993    .02774    .02576
10............................................................    .03704    .03423    .03170    .02941    .02735
11............................................................    .03918    .03626    .03363    .03125    .02910
12............................................................    .04148    .03845    .03571    .03323    .03099
13............................................................    .04387    .04073    .03788    .03531    .03297
14............................................................    .04632    .04305    .04010    .03742    .03499
15............................................................    .04876    .04538    .04231    .03953    .03699
16............................................................    .05118    .04767    .04449    .04159    .03896
17............................................................    .05357    .04994    .04663    .04362    .04088
18............................................................    .05598    .05221    .04878    .04565    .04280
19............................................................    .05843    .05453    .05097    .04772    .04476
20............................................................    .06099    .05694    .05325    .04988    .04679
21............................................................    .06365    .05946    .05564    .05213    .04893
22............................................................    .06644    .06210    .05813    .05449    .05116
23............................................................    .06937    .06488    .06076    .05699    .05352
24............................................................    .07249    .06784    .06357    .05965    .05605
25............................................................    .07584    .07103    .06660    .06254    .05879
26............................................................    .07945    .07447    .06989    .06567    .06178
27............................................................    .08334    .07819    .07345    .06907    .06503
28............................................................    .08751    .08219    .07729    .07275    .06856
29............................................................    .09194    .08645    .98137    .07667    .07233
30............................................................    .09663    .09096    .08572    .08086    .07635
31............................................................    .10156    .09572    .09030    .08527    .08060
32............................................................    .10677    .10074    .09515    .08995    .08512
33............................................................    .11224    .10604    .10027    .09490    .08990
34............................................................    .11798    .11159    .10564    .10010    .09494
35............................................................    .12401    .11744    .11131    .10560    .10026
36............................................................    .13033    .12357    .11727    .11137    .10586
37............................................................    .13693    .12999    .12350    .11743    .11175
38............................................................    .14380    .13668    .13002    .12377    .11791
39............................................................    .15096    .14366    .13681    .13038    .12436
40............................................................    .15841    .15092    .14390    .13729    .13109
41............................................................    .16615    .15848    .15128    .14450    .13812
42............................................................    .17421    .16637    .15899    .15204    .14549
43............................................................    .18257    .17456    .16700    .15988    .15316
44............................................................    .19124    .18306    .17533    .16804    .16115
45............................................................    .20018    .19184    .18395    .17649    .16943
46............................................................    .20943    .20092    .19287    .18524    .17802
47............................................................    .21897    .21030    .20209    .19431    .18692
48............................................................    .22883    .22001    .21165    .20371    .19616
49............................................................    .23900    .23004    .22152    .21343    .20573
50............................................................    .24948    .24039    .23173    .22349    .21565
51............................................................    .26027    .25104    .24225    .23387    .22589
52............................................................    .27135    .26200    .25308    .24457    .23645
53............................................................    .28271    .27325    .26421    .25558    .24733
54............................................................    .29433    .28476    .27561    .26686    .25848
55............................................................    .30621    .29654    .28728    .27842    .26993
56............................................................    .31832    .30856    .29921    .29025    .28165
57............................................................    .33068    .32085    .31142    .30236    .29367
58............................................................    .34329    .33339    .32388    .31474    .30595
59............................................................    .35615    .34620    .33662    .32741    .31855
60............................................................    .36927    .35927    .34964    .34037    .33143
61............................................................    .38265    .37262    .36295    .35362    .34463
62............................................................    .39630    .38625    .37655    .36718    .35814
63............................................................    .41020    .40014    .39043    .38104    .37196
64............................................................    .42432    .41428    .40456    .39516    .38606
65............................................................    .43866    .42864    .41893    .40953    .40042
66............................................................    .45320    .44321    .43353    .42414    .41503
67............................................................    .46790    .45796    .44832    .43896    .42987
68............................................................    .48277    .47289    .46330    .45398    .44492
69............................................................    .49781    .48802    .47849    .46923    .46021
70............................................................    .51303    .50333    .49389    .48470    .47574
71............................................................    .52847    .51888    .50954    .50044    .49156
72............................................................    .54412    .53466    .52544    .51644    .50766
73............................................................    .55990    .55059    .54151    .52363    .52396
74............................................................    .57566    .56652    .55758    .54885    .54030
75............................................................    .59129    .58232    .57354    .56496    .55655
76............................................................    .60671    .59792    .58932    .58089    .57263
77............................................................    .62189    .61330    .60487    .59661    .58851
78............................................................    .63687    .62847    .62024    .61215    .60422
79............................................................    .65168    .64349    .63546    .62756    .61981
80............................................................    .66637    .65841    .65058    .64289    .63532
81............................................................    .68085    .67312    .66551    .65802    .65066
82............................................................    .69503    .68753    .68014    .67287    .66571
83............................................................    .70890    .70164    .69448    .68743    .68048
84............................................................    .72255    .71553    .70861    .70179    .69506
85............................................................    .73600    .72924    .72257    .71598    .70948
86............................................................    .74897     .7446    .73693    .72969    .72342
87............................................................    .76109    .75483    .74864    .74252    .73647
88............................................................    .77235    .76631    .76035    .75445    .74862
89............................................................    .78298    .77717    .77142    .76573    .76011
90............................................................    .79329    .78770    .78217    .77669    .77127
91............................................................    .80320    .79783    .79252    .78725    .78204
92............................................................    .81241    .80725    .80214    .79708    .79206
93............................................................    .82074    .81578    .81086    .80598    .80115
94............................................................    .82816    .82337    .81862    .81391    .80924
95............................................................    .83461    .82997    .82537    .82081    .81629
96............................................................    .84003    .83552    .82105    .82661    .82221
97............................................................    .84487    .84048    .83612    .82179    .82750
98............................................................    .84910    .84481    .84054    .83631    .83211
99............................................................    .85307    .84887    .84469    .84055    .83644
100...........................................................    .85701    .85290    .84882    .84476    .84073
101...........................................................    .86049    .85645    .85244    .84846    .84451

[[Page 160]]

                                                                                                                
102...........................................................    .86424    .86029    .85637    .85247    .84859
103...........................................................    .86904    .86520    .86138    .85758    .85381
104...........................................................    .87365    .86991    .86619    .86249    .85880
105...........................................................    .88058    .87700    .87343    .86988    .86635
106...........................................................    .89165    .88835    .88506    .88179    .87852
107...........................................................    .90692    .90404    .90116    .89829    .89542
108...........................................................    .93077    .92858    .92639    .92420    .92201
109...........................................................    .96900    .96800    .96700    .96600    .96500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  7.2%      7.4%      7.6%      7.8%      8.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03499    .03392    .03296    .03209    .03130
1.............................................................    .01725    .01613    .01513    .01422    .01340
2.............................................................    .01732    .01615    .01509    .01414    .01329
3.............................................................    .01778    .01656    .01545    .01446    .01356
4.............................................................    .01846    .01717    .01601    .01497    .01402
5.............................................................    .01930    .01796    .01674    .01574    .01465
6.............................................................    .02029    .01888    .01761    .01645    .01541
7.............................................................    .02138    .01991    .01857    .01736    .01627
8.............................................................    .02261    .02106    .01966    .01839    .01724
9.............................................................    .02397    .02236    .02089    .01956    .01835
10............................................................    .02548    .02379    .02225    .02086    .01959
11............................................................    .02715    .02538    .02377    .02231    .02098
12............................................................    .02895    .02710    .02542    .02389    .02250
13............................................................    .03085    .02892    .02716    .02556    .02410
14............................................................    .03278    .03076    .02893    .02725    .02572
15............................................................    .03469    .03259    .03067    .02892    .02732
16............................................................    .03656    .03437    .03237    .03054    .02886
17............................................................    .03938    .03610    .03401    .03210    .03035
18............................................................    .04020    .03782    .03564    .03364    .03181
19............................................................    .04204    .03956    .03729    .03520    .03328
20............................................................    .04397    .04138    .03901    .03683    .03483
21............................................................    .04599    .04329    .04081    .03853    .03644
22............................................................    .04810    .04529    .04270    .04032    .03813
23............................................................    .05033    .04740    .04470    .04222    .03992
24............................................................    .05273    .04968    .04686    .04427    .04187
25............................................................    .05534    .05216    .04922    .04651    .04400
26............................................................    .05819    .05488    .05182    .04898    .04636
27............................................................    .06130    .05785    .05466    .05170    .04896
28............................................................    .06468    .06109    .05777    .05468    .05182
29............................................................    .06830    .06457    .06110    .05789    .05490
30............................................................    .07217    .06829    .06469    .06134    .05822
31............................................................    .07627    .07224    .06849    .06500    .06174
32............................................................    .08062    .07644    .07254    .06891    .06552
33............................................................    .08524    .08090    .07686    .07308    .06955
34............................................................    .09012    .08562    .08142    .07749    .07382
35............................................................    .09528    .09062    .08626    .08218    .07836
36............................................................    .10071    .09589    .09137    .08714    .08317
37............................................................    .10643    .10144    .09676    .09237    .08825
38............................................................    .11242    .10727    .10243    .09788    .09361
39............................................................    .11869    .11337    .10837    .10366    .09923
40............................................................    .12526    .11977    .11460    .10973    .10514
41............................................................    .13212    .12646    .12113    .11609    .11135
42............................................................    .13931    .13349    .12799    .12279    .11789
43............................................................    .14681    .14082    .13515    .12980    .12473
44............................................................    .15463    .14847    .14264    .13712    .13189
45............................................................    .16274    .15642    .15042    .14474    .13935
46............................................................    .17117    .16468    .15853    .15268    .14713
47............................................................    .17991    .17326    .16694    .16094    .15523
48............................................................    .18900    .18219    .17571    .16955    .16368
49............................................................    .19841    .19145    .18481    .17850    .17248
50............................................................    .20818    .20106    .19428    .18781    .18163
51............................................................    .21827    .21101    .20407    .19745    .19113
52............................................................    .22869    .22129    .21421    .20745    .20098
53............................................................    .23944    .23190    .22468    .21778    .21117
54............................................................    .25047    .24280    .23545    .22841    .22167
55............................................................    .26180    .25400    .24653    .23936    .23249
56............................................................    .27341    .26550    .25790    .25061    .24361
57............................................................    .28532    .27729    .26959    .26218    .25505
58............................................................    .29751    .28938    .28157    .27405    .26681
59............................................................    .31001    .30180    .29388    .28626    .27892
60............................................................    .32282    .31452    .30652    .29880    .29136
61............................................................    .33595    .32758    .31950    .31169    .30416
62............................................................    .34941    .34097    .33282    .32494    .31733
63............................................................    .36318    .35469    .34648    .33854    .33085
64............................................................    .37725    .36872    .36046    .35246    .34472
65............................................................    .39159    .38304    .37474    .36670    .35891
66............................................................    .40620    .39763    .38931    .38124    .37340
67............................................................    .42104    .41247    .40414    .39605    .38819
68............................................................    .43611    .42755    .41923    .41113    .40326
69............................................................    .45144    .44290    .43459    .42650    .41863
70............................................................    .46702    .45852    .45025    .44218    .43432
71............................................................    .48291    .47447    .46623    .45820    .45037
72............................................................    .49909    .49072    .48255    .47458    .46679
73............................................................    .51549    .50721    .49912    .49912    .48349
74............................................................    .53195    .52377    .51578    .50796    .50031
75............................................................    .54832    .54027    .53238    .52466    .51710
76............................................................    .56454    .55661    .54884    .54123    .53377
77............................................................    .58057    .57278    .56514    .55765    .55030
78............................................................    .59644    .58879    .58129    .58393    .56670
79............................................................    .61219    .60471    .59736    .59013    .58304
80............................................................    .62788    .62057    .61338    .60632    .59936
81............................................................    .64341    .63628    .62926    .62236    .61556
82............................................................    .65866    .65172    .64488    .63815    .63151
83............................................................    .67364    .66689    .66024    .65369    .64723
84............................................................    .68843    .68189    .67544    .66907    .66279
85............................................................    .70307    .69674    .69050    .68433    .67825
86............................................................    .71723    .71112    .70508    .69912    .69323
87............................................................    .73050    .72460    .71877    .71300    .70731
88............................................................    .74285    .73715    .73151    .72593    .72042
89............................................................    .75454    .74903    .74358    .73819    .73286
90............................................................    .76591    .76060    .75534    .75014    .74499
91............................................................    .77688    .77176    .76670    .76169    .75672
92............................................................    .78709    .78217    .77729    .77245    .76766
93............................................................    .79635    .79160    .78690    .78223    .77761
94............................................................    .80461    .80002    .79547    .79096    .78648
95............................................................    .81180    .80735    .80394    .79856    .79421
96............................................................    .81784    .81351    .80921    .80494    .80071
97............................................................    .82324    .81901    .81481    .81065    .80651
98............................................................    .82794    .82380    .81969    .81562    .81157
99............................................................    .83235    .82830    .83427    .82028    .81631
100...........................................................    .83674    .83276    .82882    .82490    .82101
101...........................................................    .84058    .83668    .83280    .82895    .82512
102...........................................................    .84474    .84091    .83710    .83332    .82956
103...........................................................    .85006    .84633    .84262    .83893    .83526
104...........................................................    .85514    .85150    .84787    .84427    .84068
105...........................................................    .86284    .85934    .85585    .85239    .84893
106...........................................................    .87527    .87204    .86881    .86559    .86239
107...........................................................    .89257    .88972    .88688    .88404    .88121
108...........................................................    .91983    .91765    .91547    .91330    .91113
109...........................................................    .96400    .96300    .96200    .96100    .96000
----------------------------------------------------------------------------------------------------------------


[[Page 161]]


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  8.2%      8.4%      8.6%      8.8%      9.0%  
----------------------------------------------------------------------------------------------------------------
0.............................................................    .03059    .02995    .02936    .02882    .02833
1.............................................................    .01267    .01200    .01139    .01084    .01033
2.............................................................    .01251    .01181    .01117    .01059    .01006
3.............................................................    .01274    .01200    .01133    .01072    .01016
4.............................................................    .01316    .01239    .01168    .01103    .01044
5.............................................................    .01375    .01293    .01218    .01150    .01088
6.............................................................    .01446    .01360    .01281    .01209    .01144
7.............................................................    .01527    .01436    .01353    .01277    .01208
8.............................................................    .01619    .01523    .01436    .01356    .01283
9.............................................................    .01725    .01624    .01532    .01448    .01370
10............................................................    .01843    .01737    .01640    .01551    .01470
11............................................................    .01976    .01865    .01763    .01669    .01583
12............................................................    .02122    .02005    .01898    .01800    .01709
13............................................................    .02276    .02153    .02041    .01937    .01842
14............................................................    .02432    .02303    .02185    .02077    .01977
15............................................................    .02585    .02451    .02327    .02213    .02108
16............................................................    .02732    .02591    .02462    .02342    .02232
17............................................................    .02874    .02726    .02590    .02465    .02349
18............................................................    .03013    .02858    .02715    .02584    .02462
19............................................................    .03152    .02990    .02841    .02703    .02575
20............................................................    .03298    .03128    .02971    .02826    .02692
21............................................................    .03451    .03272    .03108    .02956    .02815
22............................................................    .03611    .03424    .03251    .03091    .02944
23............................................................    .03781    .03585    .03404    .03236    .03081
24............................................................    .03965    .03760    .03570    .03393    .03230
25............................................................    .04168    .03953    .03753    .03568    .03396
26............................................................    .04393    .04168    .03958    .03764    .03583
27............................................................    .04642    .04406    .04186    .03982    .03792
28............................................................    .04916    .04669    .04439    .04224    .04025
29............................................................    .05212    .04953    .04712    .04487    .04277
30............................................................    .05531    .05260    .05008    .04772    .04552
31............................................................    .05871    .05588    .05324    .05077    .04846
32............................................................    .06236    .05940    .05663    .05405    .05163
33............................................................    .06625    .06316    .06027    .05756    .05502
34............................................................    .07038    .06716    .06414    .06131    .05865
35............................................................    .07478    .07142    .06827    .06531    .06253
36............................................................    .07944    .07595    .07266    .06957    .06667
37............................................................    .08438    .08074    .07732    .07410    .07106
38............................................................    .08958    .08580    .08223    .07888    .07571
39............................................................    .09506    .09112    .08742    .08392    .08061
40............................................................    .10081    .09673    .09288    .08924    .08580
41............................................................    .10687    .10263    .09863    .09484    .09126
42............................................................    .11325    .10886    .10471    .10078    .09705
43............................................................    .11993    .11539    .11109    .10701    .10314
44............................................................    .12694    .12224    .11779    .11356    .10955
45............................................................    .13424    .12939    .12478    .12040    .11624
46............................................................    .14186    .13686    .13210    .12757    .12326
47............................................................    .14980    .14464    .13973    .13505    .13059
48............................................................    .15810    .15278    .14772    .14289    .13828
49............................................................    .16674    .16127    .15605    .15107    .14631
50............................................................    .17574    .17012    .16475    .15962    .15472
51............................................................    .18510    .17932    .17381    .16853    .16348
52............................................................    .19480    .18888    .18322    .17779    .17260
53............................................................    .20484    .19878    .19298    .18741    .18208
54............................................................    .21520    .20901    .20306    .19735    .19188
55............................................................    .22589    .21955    .21347    .20763    .20202
56............................................................    .23688    .23041    .22420    .21822    .21248
57............................................................    .24820    .24161    .23527    .22917    .22329
58............................................................    .25984    .25313    .24667    .24044    .23444
59............................................................    .27184    .26501    .25843    .25209    .24596
60............................................................    .28417    .27724    .27055    .26409    .25786
61............................................................    .29688    .28985    .28306    .27650    .27015
62............................................................    .30996    .30284    .29596    .28929    .28285
63............................................................    .32341    .31621    .30924    .30249    .29595
64............................................................    .33721    .32994    .32289    .31605    .30943
65............................................................    .35134    .34401    .33689    .32999    .32329
66............................................................    .36580    .35841    .35124    .34427    .33750
67............................................................    .38055    .37312    .36590    .35889    .35206
68............................................................    .39559    .38814    .38089    .37383    .36696
69............................................................    .41096    .40349    .39622    .38913    .38222
70............................................................    .42665    .41918    .41190    .40480    .39787
71............................................................    .44273    .43527    .42799    .42089    .41395
72............................................................    .45919    .45176    .44450    .43741    .43049
73............................................................    .47594    .46856    .46134    .45428    .44738
74............................................................    .49283    .48550    .47834    .47132    .46446
75............................................................    .50969    .50244    .49534    .48838    .48157
76............................................................    .52646    .51929    .51226    .50537    .49862
77............................................................    .54309    .53601    .52907    .52226    .51558
78............................................................    .55960    .55263    .54579    .53907    .53247
79............................................................    .57606    .56921    .56248    .55586    .54935
80............................................................    .59253    .58580    .57919    .57269    .56629
81............................................................    .60887    .60229    .59581    .58943    .58315
82............................................................    .62498    .61855    .61221    .60597    .59982
83............................................................    .64086    .63459    .62840    .62230    .61629
84............................................................    .65660    .65049    .64447    .63852    .63266
85............................................................    .67224    .66631    .66046    .65468    .64898
86............................................................    .68742    .68167    .67600    .67040    .66486
87............................................................    .70168    .69611    .69061    .68518    .67980
88............................................................    .71497    .70958    .70425    .69897    .69376
89............................................................    .72758    .72236    .71720    .71208    .70702
90............................................................    .73989    .73484    .72985    .72490    .72000
91............................................................    .75180    .74693    .74210    .73732    .73259
92............................................................    .76292    .75821    .75355    .74894    .74436
93............................................................    .77302    .76848    .76397    .75951    .75508
94............................................................    .78204    .77764    .77328    .76895    .76466
95............................................................    .78991    .78563    .78139    .77719    .77302
96............................................................    .79651    .79234    .78821    .78411    .78003
97............................................................    .80241    .79834    .79430    .79029    .78630
98............................................................    .80755    .80356    .79960    .79567    .79176
99............................................................    .81236    .80845    .80456    .80071    .79687
100...........................................................    .81715    .81331    .80949    .80571    .80195
101...........................................................    .82132    .81754    .81379    .81006    .80636
102...........................................................    .82582    .82211    .81842    .81476    .81111
103...........................................................    .83162    .82799    .82439    .82080    .81724
104...........................................................    .83711    .83356    .83003    .82652    .82302
105...........................................................    .84550    .84208    .83867    .83528    .83191
106...........................................................    .85920    .85602    .85285    .84969    .84655
107...........................................................    .87839    .87558    .87277    .86997    .86718
108...........................................................    .90896    .90679    .90463    .90246    .90030
109...........................................................    .95900    .95800    .95700    .95600    .95500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout Rate            
                            (1) Age                            -------------------------------------------------
                                                                  9.2%      9.4%      9.6%      9.8%      10.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02788    .02747    .02709    .02673    .02641
1.............................................................    .00987    .00945    .00906    .00871    .00838
2.............................................................    .00957    .00913    .00872    .00835    .00800
3.............................................................    .00965    .00918    .00875    .00836    .00799
4.............................................................    .00991    .00941    .00896    .00854    .00815
5.............................................................    .01031    .00979    .00931    .00887    .00846
6.............................................................    .01084    .01028    .00978    .00931    .00888
7.............................................................    .01144    .01086    .01032    .00983    .00937
8.............................................................    .01216    .01154    .01097    .01044    .00996

[[Page 162]]

                                                                                                                
9.............................................................    .01299    .01234    .01174    .01118    .01067
10............................................................    .01395    .01326    .01262    .01204    .01149
11............................................................    .01504    .01432    .01364    .01302    .01245
12............................................................    .01626    .01549    .01478    .01413    .01352
13............................................................    .01755    .01674    .01599    .01530    .01466
14............................................................    .01885    .01800    .01721    .01648    .01581
15............................................................    .02011    .01922    .01839    .01762    .01691
16............................................................    .02130    .02036    .01949    .01869    .01794
17............................................................    .02243    .02144    .02052    .01967    .01888
18............................................................    .02350    .02246    .02150    .02061    .01978
19............................................................    .02457    .02348    .02247    .02153    .02065
20............................................................    .02569    .02454    .02347    .02248    .02156
21............................................................    .02685    .02564    .02452    .02347    .02250
22............................................................    .02806    .02679    .02561    .02451    .02348
23............................................................    .02936    .02802    .02677    .02561    .02453
24............................................................    .03078    .02937    .02805    .02683    .02569
25............................................................    .03236    .03087    .02949    .02820    .02699
26............................................................    .03415    .03258    .03112    .02975    .02848
27............................................................    .03615    .03450    .03295    .03151    .03017
28............................................................    .03838    .03664    .03502    .03350    .03208
29............................................................    .04081    .03898    .03727    .03567    .03416
30............................................................    .04346    .04154    .03973    .03804    .03646
31............................................................    .04630    .04427    .04237    .04059    .03892
32............................................................    .04936    .04723    .04523    .04335    .04159
33............................................................    .05264    .05041    .04831    .04633    .04448
34............................................................    .05615    .05381    .05160    .04952    .04757
35............................................................    .05992    .05746    .05514    .05296    .05090
36............................................................    .06393    .06135    .05892    .05663    .05447
37............................................................    .06820    .06550    .06295    .06055    .05828
38............................................................    .07272    .06990    .06723    .06471    .06233
39............................................................    .07749    .07454    .07175    .06912    .06662
40............................................................    .08254    .07946    .07655    .07379    .07117
41............................................................    .08787    .08466    .08162    .07073    .07599
42............................................................    .09352    .09018    .08700    .08399    .08112
43............................................................    .09947    .09599    .09268    .08953    .08654
44............................................................    .10573    .10211    .09866    .09539    .09227
45............................................................    .11229    .10852    .10494    .10152    .09827
46............................................................    .11916    .11525    .11153    .10798    .10459
47............................................................    .12634    .12229    .11843    .11474    .11122
48............................................................    .13388    .12969    .12568    .12186    .11820
49............................................................    .14177    .13743    .13329    .12932    .12553
50............................................................    .15003    .14555    .14126    .13716    .13322
51............................................................    .15865    .15402    .14959    .14534    .14127
52............................................................    .16763    .16286    .15828    .15390    .14969
53............................................................    .17696    .17205    .16734    .16281    .15847
54............................................................    .18662    .18157    .17672    .17206    .16758
55............................................................    .19662    .19144    .18645    .18165    .17703
56............................................................    .20695    .20163    .19651    .19157    .18682
57............................................................    .21763    .21218    .20693    .20186    .19698
58............................................................    .22865    .22307    .21769    .21250    .20749
59............................................................    .24005    .23435    .22885    .22353    .21839
60............................................................    .25183    .24601    .24038    .23494    .22969
61............................................................    .26401    .25808    .25234    .24678    .24141
62............................................................    .27661    .27056    .26471    .25905    .25356
63............................................................    .28961    .28347    .27752    .27175    .26615
64............................................................    .30300    .29677    .29072    .28486    .27916
65............................................................    .31678    .31046    .30433    .29837    .29259
66............................................................    .33093    .32454    .31832    .31228    .30641
67............................................................    .34542    .33897    .33268    .32657    .32062
68............................................................    .36027    .35376    .34742    .34124    .33522
69............................................................    .37550    .36894    .36255    .35632    .35024
70............................................................    .39111    .38452    .37809    .37182    .36570
71............................................................    .40719    .40058    .39412    .38782    .38166
72............................................................    .42372    .41710    .41064    .40432    .39814
73............................................................    .44062    .43402    .42756    .42124    .41506
74............................................................    .45774    .45116    .44471    .43840    .43223
75............................................................    .47489    .46834    .46193    .45565    .44949
76............................................................    .49199    .48550    .47913    .47288    .46675
77............................................................    .50902    .50258    .49626    .49006    .48397
78............................................................    .52598    .51962    .51336    .50721    .50117
79............................................................    .54295    .53667    .53049    .52441    .51843
80............................................................    .55999    .55380    .54771    .54171    .53581
81............................................................    .57697    .57088    .56489    .55899    .55317
82............................................................    .59375    .58778    .58190    .57610    .57039
83............................................................    .61036    .60451    .59875    .59306    .58746
84............................................................    .62687    .62116    .61553    .60997    .60448
85............................................................    .64335    .63779    .63230    .62688    .62152
86............................................................    .65939    .65398    .64864    .64337    .63816
87............................................................    .67449    .66924    .66405    .65892    .65384
88............................................................    .68860    .68350    .67845    .67346    .66852
89............................................................    .70202    .69706    .69216    .68731    .68250
90............................................................    .71515    .71035    .70559    .70088    .69622
91............................................................    .72790    .72325    .71865    .71409    .70957
92............................................................    .73982    .73533    .73087    .72646    .72208
93............................................................    .75069    .74634    .74202    .73774    .73350
94............................................................    .76040    .75618    .75199    .74784    .74372
95............................................................    .76888    .76477    .76070    .75666    .75265
96............................................................    .77599    .77199    .76801    .76406    .76014
97............................................................    .78235    .77843    .77454    .77067    .76684
98............................................................    .78789    .78404    .78022    .77642    .77266
99............................................................    .79307    .78929    .78554    .78181    .77811
100...........................................................    .79821    .79450    .79081    .78715    .78351
101...........................................................    .80268    .79902    .79539    .79178    .78819
102...........................................................    .80749    .80389    .80031    .79676    .79322
103...........................................................    .81370    .81018    .80668    .80319    .79973
104...........................................................    .81955    .81609    .81265    .80923    .80582
105...........................................................    .82855    .82520    .82187    .81856    .81526
106...........................................................    .84341    .84029    .83718    .83408    .83099
107...........................................................    .86439    .86162    .85884    .85608    .85332
108...........................................................    .89815    .89599    .89384    .89169    .88955
109...........................................................    .95400    .95300    .95200    .95100    .95000
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  10.2%     10.4%     10.6%     10.8%     11.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02610    .02582    .02556    .02531    .02508
1.............................................................    .00807    .00779    .00753    .00729    .00707
2.............................................................    .00769    .00739    .00712    .00686    .00663
3.............................................................    .00766    .00735    .00706    .00679    .00654
4.............................................................    .00780    .00747    .00716    .00688    .00662
5.............................................................    .00808    .00773    .00741    .00711    .00683
6.............................................................    .00848    .00811    .00776    .00744    .00715
7.............................................................    .00894    .00855    .00819    .00785    .00753
8.............................................................    .00951    .00909    .00871    .00835    .00801
9.............................................................    .01019    .00975    .00934    .00896    .00860
10............................................................    .01099    .01052    .01008    .00967    .00930
11............................................................    .01191    .01142    .01095    .01052    .01012
12............................................................    .01295    .01243    .01194    .01148    .01106
13............................................................    .01406    .01351    .01299    .01251    .01206
14............................................................    .01518    .01459    .01405    .01354    .01306
15............................................................    .01625    .01563    .01506    .01452    .01402
16............................................................    .01724    .01659    .01599    .01542    .01489
17............................................................    .01815    .01747    .01683    .01624    .01568

[[Page 163]]

                                                                                                                
18............................................................    .01901    .01829    .01761    .01699    .01640
19............................................................    .01984    .01908    .01837    .01771    .01709
20............................................................    .02070    .01990    .01915    .01846    .01780
21............................................................    .02160    .02075    .01996    .01923    .01854
22............................................................    .02253    .02164    .02080    .02003    .01930
23............................................................    .02352    .02258    .02170    .02088    .02010
24............................................................    .02462    .02362    .02269    .02182    .02100
25............................................................    .02586    .02481    .02382    .02289    .02203
26............................................................    .02729    .02617    .02512    .02414    .02322
27............................................................    .02891    .02772    .02662    .02558    .02460
28............................................................    .03074    .02949    .02832    .02722    .02618
29............................................................    .03276    .03143    .03019    .02902    .02792
30............................................................    .03497    .03357    .03225    .03102    .02985
31............................................................    .03735    .03587    .03448    .03317    .03193
32............................................................    .03993    .03837    .03690    .03551    .03420
33............................................................    .04273    .04108    .03952    .03806    .03667
34............................................................    .04572    .04399    .04234    .04079    .03933
35............................................................    .04896    .04713    .04539    .04376    .04221
36............................................................    .05243    .05049    .04867    .04694    .04530
37............................................................    .05613    .05410    .05217    .05035    .04862
38............................................................    .06007    .05793    .05591    .05399    .05217
39............................................................    .06425    .06200    .05987    .05785    .05593
40............................................................    .06869    .06633    .06409    .06197    .05995
41............................................................    .07339    .07092    .06857    .06634    .06421
42............................................................    .07840    .07581    .07335    .07101    .06878
43............................................................    .08370    .08099    .07841    .07595    .07361
44............................................................    .08930    .08646    .08377    .08119    .07874
45............................................................    .09517    .09222    .08940    .08670    .08413
46............................................................    .10136    .09828    .09533    .09252    .08983
47............................................................    .10786    .10464    .10157    .09864    .09582
48............................................................    .11470    .11136    .10816    .10510    .10216
49............................................................    .12189    .11842    .11509    .11190    .10884
50............................................................    .12946    .12585    .12239    .11907    .11588
51............................................................    .13737    .13363    .13003    .12659    .12327
52............................................................    .14565    .14177    .13805    .13447    .13103
53............................................................    .15429    .15028    .14642    .14271    .13914
54............................................................    .16327    .15912    .15513    .15129    .14759
55............................................................    .17259    .16831    .16419    .16022    .15639
56............................................................    .18225    .17784    .17358    .16948    .16553
57............................................................    .19227    .18773    .18335    .17912    .17503
58............................................................    .20265    .19798    .19347    .18911    .18490
59............................................................    .21343    .20863    .20400    .19951    .19518
60............................................................    .22460    .21968    .21492    .21032    .20586
61............................................................    .23620    .23117    .22629    .22156    .21698
62............................................................    .24824    .24309    .23810    .23325    .22856
63............................................................    .26073    .25546    .25036    .24540    .24060
64............................................................    .27364    .26827    .26306    .25800    .25308
65............................................................    .28696    .28150    .27619    .27103    .26601
66............................................................    .30070    .29515    .28974    .28449    .27937
67............................................................    .31483    .30919    .30371    .29836    .29316
68............................................................    .32936    .32365    .31808    .31266    .30737
69............................................................    .34432    .33854    .33290    .32741    .32204
70............................................................    .35972    .35389    .34820    .34264    .33721
71............................................................    .37565    .36977    .36403    .35842    .35294
72............................................................    .39210    .38619    .38042    .37477    .36924
73............................................................    .40900    .40308    .39728    .39161    .38605
74............................................................    .42618    .42025    .41444    .40876    .40318
75............................................................    .44345    .43753    .43173    .42604    .42046
76............................................................    .46073    .45483    .44904    .44336    .43779
77............................................................    .47799    .47212    .46635    .46069    .45513
78............................................................    .49524    .48941    .48368    .47805    .47252
79............................................................    .51256    .50678    .50110    .49551    .49001
80............................................................    .53001    .52429    .51867    .51313    .50769
81............................................................    .54745    .54181    .53626    .53079    .52541
82............................................................    .56476    .55921    .55374    .54835    .54303
83............................................................    .58193    .57648    .57110    .56579    .56056
84............................................................    .59907    .59373    .58845    .58325    .57811
85............................................................    .61624    .61102    .60586    .60077    .59574
86............................................................    .63300    .62791    .62289    .61791    .61300
87............................................................    .64883    .64387    .63896    .63411    .62932
88............................................................    .66363    .65880    .65402    .64929    .64461
89............................................................    .67775    .67304    .66838    .66377    .65921
90............................................................    .69160    .68703    .68250    .67802    .67357
91............................................................    .70509    .70066    .69626    .69191    .68760
92............................................................    .71775    .71345    .70919    .70496    .70078
93............................................................    .72929    .72512    .72099    .71689    .71282
94............................................................    .73964    .73559    .73157    .72758    .72362
95............................................................    .74867    .74472    .74081    .73692    .73306
96............................................................    .75625    .75239    .74856    .74476    .74099
97............................................................    .76303    .75925    .75550    .75177    .74807
98............................................................    .76892    .76521    .76152    .75786    .75422
99............................................................    .77443    .77078    .76715    .76355    .75998
100...........................................................    .77990    .77631    .77275    .76921    .76569
101...........................................................    .78463    .78109    .77757    .77407    .77060
102...........................................................    .78971    .78622    .78275    .77930    .77587
103...........................................................    .79629    .79287    .78947    .78608    .78272
104...........................................................    .80244    .79907    .79572    .79239    .78907
105...........................................................    .81198    .80871    .80546    .88222    .79900
106...........................................................    .82792    .82485    .82180    .81876    .81572
107...........................................................    .85057    .84783    .84509    .84237    .83964
108...........................................................    .88740    .88526    .88312    .88098    .87885
109...........................................................    .94900    .94800    .94700    .94600    .94500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  11.2%     11.4%     11.6%     11.8%     12.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02487    .02466    .02447    .02429    .02412
1.............................................................    .00686    .00666    .00648    .00631    .00615
2.............................................................    .00641    .00620    .00601    .00583    .00566
3.............................................................    .00631    .00609    .00589    .00570    .00552
4.............................................................    .00637    .00614    .00593    .00573    .00554
5.............................................................    .00657    .00633    .00610    .00588    .00568
6.............................................................    .00687    .00661    .00637    .00614    .00593
7.............................................................    .00724    .00696    .00670    .00646    .00623
8.............................................................    .00770    .00740    .00713    .00687    .00663
9.............................................................    .00827    .00795    .00766    .00739    .00713
10............................................................    .00894    .00861    .00830    .00800    .00773
11............................................................    .00974    .00939    .00906    .00875    .00846
12............................................................    .01066    .01029    .00993    .00961    .00929
13............................................................    .01164    .01124    .01087    .01052    .01019
14............................................................    .01262    .01220    .01181    .01144    .01109
15............................................................    .01355    .01311    .01270    .01231    .01194
16............................................................    .01440    .01394    .01350    .01309    .01271
17............................................................    .01516    .01467    .01421    .01378    .01337
18............................................................    .01585    .01534    .01485    .01440    .01397
19............................................................    .01651    .01597    .01546    .01498    .01453
20............................................................    .01719    .01662    .01608    .01557    .01510
21............................................................    .01789    .01728    .01672    .01618    .01568
22............................................................    .01861    .01797    .01737    .01680    .01627
23............................................................    .01938    .01870    .01806    .01746    .01689
24............................................................    .02023    .01951    .01883    .01819    .01759
25............................................................    .02121    .02045    .01973    .01905    .01841
26............................................................    .02236    .02155    .02078    .02006    .01938

[[Page 164]]

                                                                                                                
27............................................................    .02368    .02282    .02200    .02124    .02051
28............................................................    .02521    .02429    .02342    .02261    .02183
29............................................................    .02689    .02591    .02499    .02412    .02330
30............................................................    .02875    .02772    .02674    .02581    .02494
31............................................................    .03076    .02966    .02863    .02764    .02671
32............................................................    .03297    .03180    .03070    .02965    .02866
33............................................................    .03536    .03412    .03295    .03184    .03079
34............................................................    .03794    .03663    .03539    .03421    .03309
35............................................................    .04074    .03935    .03803    .03678    .03559
36............................................................    .04375    .04228    .04089    .03956    .03830
37............................................................    .04699    .04543    .04395    .04255    .04122
38............................................................    .05044    .04879    .04723    .04575    .04433
39............................................................    .05411    .05238     .5073    .04916    .04766
40............................................................    .05802    .05620    .05445    .05279    .05121
41............................................................    .06219    .06026    .05843    .05668    .05550
42............................................................    .06665    .06462    .06269    .06084    .05908
43............................................................    .07138    .06924    .06721    .06526    .06341
44............................................................    .07639    .07415    .07202    .06997    .06801
45............................................................    .08168    .07933    .07708    .07493    .07287
46............................................................    .08726    .08480    .08244    .08018    .07802
47............................................................    .09313    .09056    .08809    .08572    .08345
48............................................................    .09935    .09666    .09408    .09160    .08922
49............................................................    .10591    .10309    .10039    .09780    .09531
50............................................................    .11282    .10989    .10707    .10436    .10176
51............................................................    .12009    .11703    .11409    .11127    .10855
52............................................................    .12772    .12454    .12147    .11853    .11569
53............................................................    .13571    .13340    .12922    .12615    .12319
54............................................................    .14403    .14060    .13729    .13410    .13102
55............................................................    .15270    .14914    .14571    .14240    .13920
56............................................................    .16171    .15802    .15447    .15103    .14771
57............................................................    .17109    .16728    .16360    .16004    .15660
58............................................................    .18083    .17690    .17309    .16941    .16585
59............................................................    .19098    .18692    .18299    .17919    .17551
60............................................................    .20154    .19736    .19331    .18938    .18558
61............................................................    .21254    .20824    .20407    .20003    .19610
62............................................................    .22400    .21958    .21530    .21113    .20709
63............................................................    .23593    .23139    .22699    .22272    .21856
64............................................................    .24830    .24366    .23915    .23476    .23050
65............................................................    .26113    .25638    .25176    .24727    .24290
66............................................................    .27439    .26955    .26483    .26023    .25576
67............................................................    .28808    .28314    .27833    .27364    .26906
68............................................................    .30221    .29718    .29228    .28750    .28283
69............................................................    .31681    .31170    .30672    .30185    .29710
70............................................................    .33190    .32673    .32167    .31672    .31189
71............................................................    .34758    .34234    .33721    .33220    .32731
72............................................................    .36384     35855    .35337    .34831    .34335
73............................................................    .38061    .37529    .37007    .36496    .35996
74............................................................    .39772    .39237    .38713    .38199    .37695
75............................................................    .41499    .40962    .40436    .39920    .39413
76............................................................    .43232    .42695    .42168    .41650    .41142
77............................................................    .44967    .44431    .43904    .43386    .42878
78............................................................    .46708    .46173    .45647    .45130    .44622
79............................................................    .48460    .47928    .47405    .46890    .46383
80............................................................    .50232    .49705    .49185    .48673    .48169
81............................................................    .52010    .51487    .50973    .50465    .49965
82............................................................    .53779    .53263    .52754    .52252    .51757
83............................................................    .55540    .55031    .54529    .54033    .53544
84............................................................    .57304    .56804    .56309    .55822    .55340
85............................................................    .59077    .58586    .58102    .57623    .57150
86............................................................    .60815    .60335    .59860    .59392    .58928
87............................................................    .62458    .61989    .61525    .61066    .60613
88............................................................    .63998    .63540    .63086    .62638    .62194
89............................................................    .65469    .65022    .64579    .64141    .63707
90............................................................    .66918    .66482    .66050    .65623    .65199
91............................................................    .68332    .67909    .67489    .67073    .66661
92............................................................    .69662    .69251    .68843    .68439    .68038
93............................................................    .70879    .70479    .70082    .69689    .69299
94............................................................    .71970    .71581    .71195    .70812    .70432
95............................................................    .72924    .72544    .72167    .71793    .71422
96............................................................    .73724    .73353    .72984    .72618    .72254
97............................................................    .74440    .74076    .73714    .73354    .72998
98............................................................    .75061    .74703    .74347    .73994    .73643
99............................................................    .75642    .75290    .74939    .74591    .74245
100...........................................................    .76219    .75872    .75527    .75184    .74844
101...........................................................    .76715    .76372    .76031    .75692    .75356
102...........................................................    .77246    .76908    .76571    .76236    .75904
103...........................................................    .77937    .77605    .77274    .76945    .76618
104...........................................................    .78577    .78249    .77923    .77598    .77275
105...........................................................    .79579    .79259    .78941    .78625    .78310
106...........................................................    .81270    .80969    .80670    .80371    .80073
107...........................................................    .83693    .83422    .83152    .82883    .82614
108...........................................................    .87672    .87459    .87246    .87034    .86822
109...........................................................    .94400    .94300    .94200    .94100    .94000
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  12.2%     12.4%     12.6%     12.8%     13.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02396    .02380    .02366    .02352    .02338
1.............................................................    .00600    .00585    .00572    .00559    .00547
2.............................................................    .00550    .00535    .00521    .00508    .00495
3.............................................................    .00536    .00520    .00505    .00491    .00478
4.............................................................    .00536    .00519    .00504    .00489    .00475
5.............................................................    .00549    .00532    .00515    .00499    .00484
6.............................................................    .00572    .00554    .00536    .00519    .00503
7.............................................................    .00602    .00582    .00563    .00545    .00528
8.............................................................    .00640    .00618    .00598    .00579    .00561
9.............................................................    .00688    .00665    .00644    .00623    .00604
10............................................................    .00747    .00723    .00699    .00678    .00657
11............................................................    .00818    .00792    .00767    .00744    .00722
12............................................................    .00900    .00873    .00846    .00822    .00798
13............................................................    .00988    .00959    .00931    .00905    .00880
14............................................................    .01077    .01046    .01017    .00989    .00963
15............................................................    .01160    .01127    .01097    .01067    .01040
16............................................................    .01234    .01200    .01167    .01137    .01108
17............................................................    .01299    .01263    .01229    .01197    .01166
18............................................................    .01357    .01319    .01283    .01249    .01217
19............................................................    .01410    .01370    .01332    .01297    .01263
20............................................................    .01465    .01422    .01382    .01345    .01309
21............................................................    .01520    .01475    .01433    .01393    .01355
22............................................................    .01576    .01529    .01484    .01442    .01402
23............................................................    .01636    .01586    .01538    .01493    .01450
24............................................................    .01703    .01649    .01599    .01551    .01505
25............................................................    .01781    .01724    .01670    .01619    .01571
26............................................................    .01874    .01813    .01756    .01701    .01650
27............................................................    .01983    .01918    .01857    .01799    .01744
28............................................................    .02111    .02042    .01976    .01915    .01856
29............................................................    .02253    .02179    .02110    .02044    .01981
30............................................................    .02411    .02333    .02259    .02188    .02121
31............................................................    .02583    .02500    .02421    .02345    .02274
32............................................................    .02772    .02683    .02599    .02519    .02443
33............................................................    .02979    .02885    .02795    .02709    .02628
34............................................................    .03203    .03102    .03006    .02915    .02829
35............................................................    .03447    .03340    .03238    .03141    .03048

[[Page 165]]

                                                                                                                
36............................................................    .03710    .03597    .03488    .03385    .03286
37............................................................    .03995    .03874    .03758    .03649    .03544
38............................................................    .04299    .04170    .04048    .03931    .03820
39............................................................    .04623    .04487    .04358    .04234    .04115
40............................................................    .04970    .04826    .04689    .04558    .04432
41............................................................    .05341    .05189    .05043    .04904    .04771
42............................................................    .05739    .05578    .05424    .05277    .05136
43............................................................    .06163    .05993    .05830    .05674    .05525
44............................................................    .06614    .06435    .06263    .06099    .05941
45............................................................    .07090    .06901    .06720    .06547    .06380
46............................................................    .07595    .07396    .07206    .07023    .06847
47............................................................    .08128    .07919    .07718    .07525    .07340
48............................................................    .08693    .08474    .08263    .08061    .07866
49............................................................    .09291    .09061    .08840    .08627    .08423
50............................................................    .09925    .09684    .09452    .09229    .09014
51............................................................    .10593    .10341    .10098    .09864    .09638
52............................................................    .11296    .11032    .10778    .10534    .10297
53............................................................    .12034    .11759    .11494    .11238    .10991
54............................................................    .12805    .12519    .12243    .11976    .11718
55............................................................    .13611    .13313    .13025    .12747    .12478
56............................................................    .14451    .14141    .13841    .13551    .13271
57............................................................    .15327    .15005    .14694    .14393    .14101
58............................................................    .16240    .15906    .15583    .15270    .14967
59............................................................    .17194    .16848    .16513    .16189    .15874
60............................................................    .18189    .17831    .17485    .17148    .16822
61............................................................    .19230    .18860    .18502    .18154    .17816
62............................................................    .20317    .19936    .19566    .19207    .18857
63............................................................    .21453    .21060    .20679    .20308    .19947
64............................................................    .22635    .22231    .21839    .21457    .21085
65............................................................    .23864    .23450    .23046    .22653    .22271
66............................................................    .25140    .24715    .24301    .23898    .23505
67............................................................    .26461    .26026    .25602    .25188    .24785
68............................................................    .27828    .27384    .26950    .26527    .26114
69............................................................    .29246    .28793    .28350    .27918    .27496
70............................................................    .30718    .30256    .29805    .29364    .28933
71............................................................    .32251    .31783    .31324    .30876    .30437
72............................................................    .33850    .33375    .32910    .32455    .32009
73............................................................    .35506    .35026    .34555    .34094    .33642
74............................................................    .37201    .36716    .36241    .35776    .35319
75............................................................    .38916    .38429    .37950    .37481    .37020
76............................................................    .40644    .40154    .39673    .39200    .38737
77............................................................    .42378    .41887    .41404    .40930    .40464
78............................................................    .44123    .43631    .43148    .42673    .42205
79............................................................    .45885    .45394    .44911    .44436    .43969
80............................................................    .47673    .47184    .46703    .46229    .45763
81............................................................    .49473    .48987    .48509    .48037    .47573
82............................................................    .51269    .50787    .50313    .49845    .49383
83............................................................    .53062    .52586    .52116    .51653    .51195
84............................................................    .54864    .54395    .53931    .53473    .53021
85............................................................    .56683    .56221    .55765    .55314    .54869
86............................................................    .58470    .58017    .57570    .57127    .56689
87............................................................    .60164    .59720    .59281    .58847    .58417
88............................................................    .61754    .61320    .60889    .60464    .60042
89............................................................    .63277    .62851    .62430    .62013    .61600
90............................................................    .64780    .64364    .63953    .63545    .63141
91............................................................    .66252    .65848    .65446    .65049    .64655
92............................................................    .67640    .67246    .66856    .66468    .66084
93............................................................    .68912    .68528    .68148    .67770    .67396
94............................................................    .70055    .69680    .69309    .68941    .68576
95............................................................    .71054    .70689    .70326    .69966    .69609
96............................................................    .71893    .71535    .71180    .70827    .70476
97............................................................    .72643    .72292    .71943    .71596    .71252
98............................................................    .73294    .72948    .72604    .72263    .71924
99............................................................    .73902    .73561    .73222    .72886    .72551
100...........................................................    .74506    .74170    .73836    .73504    .73174
101...........................................................    .75021    .74689    .74359    .74030    .73704
102...........................................................    .75573    .75244    .74918    .74593    .74270
103...........................................................    .76293    .75970    .75649    .75329    .75011
104...........................................................    .76954    .76634    .76316    .76000    .75685
105...........................................................    .77996    .77684    .77373    .77064    .76756
106...........................................................    .79777    .79481    .79187    .78894    .78602
107...........................................................    .82346    .82078    .81812    .81546    .81281
108...........................................................    .86610    .86398    .86187    .85976    .85765
109...........................................................    .93900    .93800    .93700    .93600    .93500
----------------------------------------------------------------------------------------------------------------


                                                     Table E                                                    
 Table E--Single Life, Unisex--Table Showing the Present Worth of the Remainder Interest in Property Transferred
   to a Unitrust Having the Adjusted Payout Rate Shown--Applicable for Transfers After November 30, 1983, and   
                                               Before May 1, 1989                                               
----------------------------------------------------------------------------------------------------------------
                                                                            (2) Adjusted payout rate            
                            (1) Age                            -------------------------------------------------
                                                                  13.2%     13.4%     13.6%     13.8%     14.0% 
----------------------------------------------------------------------------------------------------------------
0.............................................................    .02325    .02313    .02301    .02290    .02279
1.............................................................    .00536    .00525    .00514    .00505    .00495
2.............................................................    .00484    .00472    .00462    .00451    .00442
3.............................................................    .00465    .00453    .00442    .00431    .00421
4.............................................................    .00461    .00449    .00437    .00426    .00415
5.............................................................    .00470    .00457    .00444    .00432    .00421
6.............................................................    .00488    .00474    .00460    .00447    .00435
7.............................................................    .00512    .00496    .00482    .00468    .00455
8.............................................................    .00543    .00527    .00512    .00497    .00483
9.............................................................    .00585    .00568    .00551    .00536    .00521
10............................................................    .00637    .00619    .00601    .00584    .00568
11............................................................    .00701    .00681    .00662    .00644    .00627
12............................................................    .00776    .00755    .00735    .00716    .00697
13............................................................    .00857    .00734    .00813    .00793    .00773
14............................................................    .00938    .00914    .00892    .00870    .00850
15............................................................    .01014    .00989    .00965    .00942    .00921
16............................................................    .01080    .01054    .01029    .01005    .00983
17............................................................    .01137    .01109    .01083    .01058    .01035
18............................................................    .01186    .01157    .01130    .01103    .01078
19............................................................    .01230    .01300    .01171    .01143    .01117
20............................................................    .01275    .01243    .01212    .01183    .01155
21............................................................    .01319    .01285    .01253    .01222    .01193
22............................................................    .01364    .01328    .01293    .01261    .01230
23............................................................    .01410    .01372    .01336    .01301    .01268
24............................................................    .01463    .01422    .01383    .01347    .01312
25............................................................    .01525    .01482    .01441    .01401    .01364
26............................................................    .01601    .01555    .01511    .01469    .01430
27............................................................    .01692    .01643    .01596    .01551    .01509
28............................................................    .01800    .01748    .01697    .01650    .01604
29............................................................    .01922    .01865    .01812    .01760    .01712
30............................................................    .02058    .01998    .01940    .01886    .01833
31............................................................    .02206    .02142    .02080    .02022    .01966
32............................................................    .02370    .02301    .02236    .02173    .02113
33............................................................    .02550    .02477    .02407    .02340    .02276
34............................................................    .02746    .02667    .02592    .02521    .02452
35............................................................    .02960    .02876    .02796    .02719    .02646
36............................................................    .03193    .03103    .03017    .02936    .02858
37............................................................    .03444    .03348    .03257    .03170    .03087
38............................................................    .03714    .03612    .03515    .03422    .03333
39............................................................    .04002    .03894    .03791    .03692    .03597
40............................................................    .04312    .04197    .04087    .03891    .03880
41............................................................    .04643    .04521    .04404    .04292    .04185
42............................................................    .05001    .04871    .04747    .04628    .04514
43............................................................    .05382    .05245    .05113    .04987    .04865
44............................................................    .05789    .05644    .05505    .05371    .05242

[[Page 166]]

                                                                                                                
45............................................................    .06220    .06067    .05919    .05777    .05641
46............................................................    .06678    .06516    .06360    .06210    .06065
47............................................................    .07162    .06991    .06826    .06668    .06515
48............................................................    .07678    .07498    .07324    .07157    .06996
49............................................................    .08225    .08035    .07852    .07676    .07506
50............................................................    .08807    .08607    .08415    .08229    .08050
51............................................................    .09421    .09211    .09009    .08814    .08625
52............................................................    .10070    .09850    .09637    .09432    .09234
53............................................................    .10753    .10523    .10300    .10085    .09877
54............................................................    .11468    .11227    .10994    .10769    .10551
55............................................................    .12218    .11966    .11722    .11487    .11258
56............................................................    .12999    .12737    .12483    .12236    .11998
57............................................................    .13818    .13545    .13279    .13022    .12773
58............................................................    .14673    .14388    .14112    .13844    .13584
59............................................................    .15568    .15272    .14985    .14706    .14435
60............................................................    .16505    .16198    .15899    .15609    .15327
61............................................................    .17488    .17169    .16859    .16558    .16265
62............................................................    .18518    .18187    .17866    .17554    .17251
63............................................................    .19596    .19255    .18923    .18600    .18285
64............................................................    .20723    .20371    .20028    .19694    .19368
65............................................................    .21898    .21535    .21181    .20836    .20500
66............................................................    .23121    .22748    .22383    .22028    .21681
67............................................................    .24392    .24008    .23633    .23267    .22910
68............................................................    .25711    .25317    .24932    .24556    .24189
69............................................................    .27083    .26680    .26285    .25900    .25523
70............................................................    .28512    .28100    .27697    .27302    .26916
71............................................................    .30007    .29587    .29176    .28773    .28378
72............................................................    .31572    .31145    .30726    .30315    .29913
73............................................................    .33199    .32765    .32340    .31923    .31514
74............................................................    .34871    .34431    .34000    .33577    .33162
75............................................................    .36568    .36124    .35688    .35260    .34840
76............................................................    .38281    .37833    .37393    .36961    .36537
77............................................................    .40006    .39555    .39113    .38677    .38249
78............................................................    .41745    .41293    .40848    .40410    .39980
79............................................................    .43508    .43055    .42609    .42170    .41737
80............................................................    .45303    .44850    .44404    .43964    .43531
81............................................................    .47115    .46663    .46218    .45779    .45347
82............................................................    .48928    .48479    .48036    .47599    .47168
83............................................................    .50744    .50298    .49858    .49424    .48995
84............................................................    .52575    .52134    .51698    .51268    .50843
85............................................................    .54429    .53994    .53564    .53139    .52720
86............................................................    .56257    .55829    .55406    .54988    .54574
87............................................................    .57993    .57572    .57156    .56745    .56338
88............................................................    .59625    .59212    .58804    .58399    .57999
89............................................................    .61191    .60786    .60384    .59987    .59594
90............................................................    .62741    .62344    .61952    .61562    .61177
91............................................................    .64264    .63877    .63493    .63113    .62736
92............................................................    .65703    .65326    .64951    .64580    .64212
93............................................................    .67024    .66656    .66291    .65928    .65568
94............................................................    .68213    .67854    .67497    .67142    .66791
95............................................................    .69255    .68903    .68554    .68207    .67863
96............................................................    .70128    .69783    .69440    .69100    .68762
97............................................................    .70910    .70570    .70233    .69899    .69566
98............................................................    .71587    .71252    .70920    .70590    .70263
99............................................................    .72219    .71889    .71562    .71236    .70913
100...........................................................    .72847    .72522    .72189    .71877    .71558
101...........................................................    .73380    .73058    .72738    .72420    .72104
102...........................................................    .73949    .73630    .73313    .72998    .72685
103...........................................................    .74695    .74381    .74068    .73758    .73449
104...........................................................    .75372    .75060    .74751    .74442    .74136
105...........................................................    .76449    .76144    .75840    .75538    .75237
106...........................................................    .78311    .78021    .77732    .77444    .77157
107...........................................................    .81016    .80752    .80489    .80227    .79965
108...........................................................    .85554    .85344    .85134    .84924    .84715
109...........................................................    .93400    .93300    .93200    .93100    .93000
----------------------------------------------------------------------------------------------------------------


                               Table F (1)                              
  Table F(1)--10 Percent--Table Showing Factors for Computations of the 
   Adjusted Payout Rate for Certain Valuations and Payout Sequences--   
Applicable for Transfers After November 30, 1983, and Before May 1, 1989
------------------------------------------------------------------------
 (1) Number of months       (2) Factors for payout at the end of each   
by which the valuation -------------------------------------------------
   date precedes the                                                    
     first payout                                                       
-----------------------   Annual     Semiannual    Quarterly    Monthly 
             But less     period       period        period      period 
 At least      than                                                     
------------------------------------------------------------------------
  ........          1                  .976731       .965232     .957616
1.........          2     .992089      .969004       .957596     .950041
2.........          3     .984240      .961338       .950021            
3.........          4     .976454      .953733       .942505            
4.........          5     .968729      .946188                          
5.........          6     .961066      .938703                          
6.........          7     .953463      .931277                          
7.........          8     .945920                                       
8.........          9     .938436                                       
9.........         10     .931012                                       
10........         11     .923647                                       
11........         12     .916340                                       
12........                .909091                                       
------------------------------------------------------------------------



[[Page 167]]

[T.D. 8540, 59 FR 30102, 30116, 30117, 30148, June 10, 1994]

Treatment of Excess Distributions of Trusts Applicable to Taxable Years 
                  Beginning on or After January 1, 1969



Sec. 1.665(a)-0A   Excess distributions by trusts; scope of subpart D.

    (a) In general. (1) Subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code as amended by the Tax Reform Act of 
1969, is designed to tax the beneficiary of a trust that accumulates, 
rather than distributes, all or part of its income currently (i.e., an 
accumulation trust), in most cases, as if the income had been currently 
distributed to the beneficiary instead of accumulated by the trusts. 
Accordingly, subpart D provides special rules for the treatment of 
amounts paid, credited, or required to be distributed by a complex trust 
(one that is subject to subpart C (section 661 and following) of such 
part I) in any year in excess of ``distributable net income'' (as 
defined in section 643 (a)) for that year. Such an excess distribution 
is an ``accumulation distribution'' (as defined in section 665(b)). The 
special rules of subpart D are generally inapplicable to amounts paid, 
credited, or required to be distributed by a trust in a taxable year in 
which it qualifies as a simple trust (one that is subject to subpart B 
(section 651 and following) of such part I). However, see Sec. 1.665(e)-
1A(b) for rules relating to the treatment of a simple trust as a complex 
trust.
    (2) An accumulation distribution is deemed to consist of, first, 
``undistributed net income'' (as defined in section 665(a)) of the trust 
from preceding taxable years, and, after all the undistributed net 
income for all preceding taxable years has been deemed distributed, 
``undistributed capital gain'' (as defined in section 665(f)) of the 
trust for all preceding taxable years commencing with the first year 
such amounts were accumulated. An accumulation distribution of 
undistributed capital gain is a ``capital gain distribution'' (as 
defined in section 665(g)). To the extent an accumulation distribution 
exceeds the ``undistributed net income'' and ``undistributed capital 
gain'' so determined, it is deemed to consist of corpus.
    (3) The accumulation distribution is ``thrown back'' to the earliest 
``preceding taxable year'' of the trust, which, in the case of 
distributions made for a taxable year beginning after December 31, 1973, 
from a trust (other than a foreign trust created by a U.S. person), is 
any taxable year beginning after December 31, 1968. Special transitional 
rules apply for distributions made in taxable years beginning before 
January 1, 1974. In the case of a foreign trust created by a U.S. 
person, a ``preceding taxable year'' is any year of the trust to which 
the Code applies.
    (4) A distribution of undistributed net income (included in an 
accumulation distribution) and a capital gain distribution will be 
included in the income of the beneficiary in the year they are actually 
paid, credited, or required to be distributed to him. The tax on the 
distribution will be approximately the amount of tax the beneficiary 
would have paid with respect to the distribution had the income and 
capital gain been distributed to the beneficiary in the year earned by 
the trust. An additional amount equal to the ``taxes imposed on the 
trust'' for the preceding year is also deemed distributed. To prevent 
double taxation, however, the beneficiary receives a credit for such 
taxes.
    (b) Effective dates. All regulations sections under subpart D 
(sections 665 through 669) which have an ``A'' suffix (such as 
Sec. 1.665(a)A and Sec. 1.666(b)-1A) are applicable to taxable years 
beginning on or after January 1, 1969, and all references therein to 
sections 665 through 669 are references to such sections as amended by 
the Tax Reform Act of 1969. Sections without the ``A'' suffix (such as 
Sec. 1.666(b)-1) are applicable only to taxable years beginning before 
January 1, 1969, and all references therein to sections 665 through 669 
are references to such sections before amendment by the Tax Reform Act 
of 1969.
    (c) Examples. Where examples contained in the regulations under 
subpart D refer to tax rates for years after 1968, such tax rates are 
not necessarily the actual rates for such years, but are only used for 
example purposes.

[[Page 168]]

    (d) Applicability to estates. Subpart D does not apply to any 
estate.

[T.D. 7204, 37 FR 17135, Aug. 25, 1972]



Sec. 1.665(a)-1A   Undistributed net income.

    (a) Domestic trusts. The term undistributed net income, in the case 
of a trust (other than a foreign trust created by a U.S. person) means, 
for any taxable year beginning after December 31, 1968, the 
distributable net income of the trust for that year (as determined under 
section 643(a)), less:
    (1) The amount of income required to be distributed currently and 
any other amounts properly paid or credited or required to be 
distributed to beneficiaries in the taxable year as specified in section 
661(a), and
    (2) The amount of taxes imposed on the trust attributable to such 
distributable net income, as defined in Sec. 1.665 (d)-1A. The 
application of the rule in this paragraph to a taxable year of a trust 
in which income is accumulated may be illustrated by the following 
example:

    Example. Under the terms of the trust, $10,000 of income is required 
to be distributed currently to A and the trustee has discretion to make 
additional distributions to A. During the taxable year 1971 the trust 
had distributable net income of $30,100 derived from royalties and the 
trustee made distributions of $20,000 to A. The taxable income of the 
trust is $10,000 on which a tax of $2,190 is paid. The undistributed net 
income of the trust for the taxable year 1971 is $7,910, computed as 
follows:

Distributable net income..........................    $30,100           
Less:                                                                   
  Income currently distributable to A.............    $10,000           
  Other amounts distributed to A..................     10,000           
  Taxes imposed on the trust attributable to the                        
   undistributed net income (see Sec.  1.665(d)-                        
   1A)............................................      2,190           
                                                   ------------         
    Total.........................................     22,190           
                                                   ------------         
    Undistributed net income......................      7,910           
                                                                        

    (b) Foreign trusts. The undistributed net income of a foreign trust 
created by a U.S. person for any taxable year is the distributable net 
income of such trust (see Sec. 1.643(a)-6 and the examples set forth in 
paragraph (b) thereof), less:
    (1) The amount of income required to be distributed currently and 
any other amounts properly paid or credited or required to be 
distributed to beneficiaries in the taxable year as specified in section 
661(a), and
    (2) The amount of taxes imposed on such trust by chapter 1 of the 
Internal Revenue Code, which are attributable to items of income which 
are required to be included in such distributable net income.

For purposes of subparagraph (2) of this paragraph, the amount of taxes 
imposed on the trust for any taxable year by chapter 1 of the Internal 
Revenue Code is the amount of taxes imposed pursuant to section 871 
(relating to tax on non-resident alien individuals) which is properly 
allocable to the undistributed portion of the distributable net income. 
See Sec. 1.665(d)-1A. The amount of taxes imposed pursuant to section 
871 is the difference between the total tax imposed pursuant to that 
section on the foreign trust created by a U.S. person for the year and 
the amount which would have been imposed on such trust had all the 
distributable net income, as determined under section 643(a), been 
distributed. The application of the rule in this paragraph may be 
illustrated by the following examples:

    Example 1. A trust was created in 1952 under the laws of Country X 
by the transfer to a trustee in Country X of property by a U.S. person. 
The entire trust constitutes a foreign trust created by a U.S. person. 
The governing instrument of the trust provides that $7,000 of income is 
required to be distributed currently to a U.S. beneficiary and gives the 
trustee discretion to make additional distributions to the beneficiary. 
During the taxable year 1973 the trust had income of $10,000 from 
dividends of a U.S. corporation (on which Federal income taxes of $3,000 
were imposed pursuant to section 871 and withheld under section 1441, 
resulting in the receipt by the trust of cash in the amount of $7,000), 
$20,000 in capital gains from the sale of stock of a Country Y 
corporation and $30,000 from dividends of a Country X corporation, none 
of the gross income of which was derived from sources within the United 
States. No income taxes were required to be paid to Country X or Country 
Y in 1973. The trustee did not file a U.S. income tax return for the 
taxable year 1973. The distributable net income of the trust before 
distributions to the beneficiary for 1973 is $60,000 ($57,000 of which 
is cash). During 1973 the trustee made distributions to the U.S. 
beneficiary equaling one-half of the

[[Page 169]]

trust's distributable net income. Thus, the U.S. beneficiary is treated 
as having had distributed to him $5,000 (composed of $3,500 as a cash 
distribution and $1,500 as the tax imposed pursuant to section 871 and 
withheld under section 1441), representing one-half of the income from 
U.S. sources; $10,000 in cash, representing one-half of the capital 
gains from the sale of stock of the Country Y corporation; and $15,000 
in cash, representing one-half of the income from Country X sources for 
a total of $30,000. The undistributed net income of the trust at the 
close of taxable year 1973 is $28,500 computed as follows:

Distributable net income..........................    $60,000           
Less:                                                                   
  (1) Amounts distributed to the beneficiary:                           
  Income currently distributed to the beneficiary.     $7,000           
  Other amounts distributed to the beneficiary....     21,500           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary....................................      1,500           
                                                   -----------          
    Total amounts distributed to the beneficiary..     80,000           
  (2) Amount of taxes imposed on the trust under                        
   chapter 1 of the Code attributable to the                            
   undistributed net income (See Sec.  1.665 (d)-                       
   1A) $3,000 less $1,500)........................     $1,500           
                                                   -----------          
    Total.........................................    $31,500           
                                                   ------------         
    Undistributed net income......................     28,500           
                                                                        

    Example 2. The facts are the same as in example 1 except that 
property has been transferred to the trust by a person other than a U.S. 
person, and during 1973 the foreign trust created by a U.S. person was 
60 percent of the entire foreign trust. The trustee paid no income taxes 
to Country X or Country Y in 1973.
    (1) The undistributed net income of the portion of the entire trust 
which is a foreign trust created by a U.S. person for 1973 is $17,100, 
computed as follows:

Distributable net income (60% of each item of gross income of           
 entire trust):                                                         
  60% of $10,000 U.S. dividends..............................     $6,000
  60% of $20,000 Country X capital gains.....................     12,000
  60% of $30,000 Country X dividends.........................     18,000
                                                   ------------         
    Total....................................................     36,000
Less:                                                                   
  (i) Amounts distributed to the beneficiary--                          
  Income currently distributed to the beneficiary                       
   (60% of $7,000)................................     $4,200           
  Other amounts distributed to the beneficiary                          
   (60% of $21,500)...............................     12,900           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary (60% of $1,500)....................        900           
                                                   -----------          
    Total amounts distributed to the beneficiary..     18,000           
  (ii) Amount of taxes imposed on the trust under                       
   chapter 1 of the Code attributable to the                            
   undistributed net income (see Sec.  1.665 (d)-                       
   1A) (60% of $1,500)............................        900           
                                                   -----------          
    Total....................................................     18,900
                                                   ------------         
    Undistributed net income.................................     17,100
                                                                        

    (2) The undistributed net income of the portion of the entire trust 
which is not a foreign trust created by a U.S. person for 1973 is 
$11,400, computed as follows:

Distributable net income (40% of each item of gross income of           
 entire trust)                                                          
  40% of $10,000 U.S. dividends..............................     $4,000
  40% of $20,000 Country X capital gains.....................      8,000
  40% of $30,000 Country X dividends.........................     12,000
                                                   ------------         
    Total....................................................     24,000
Less:                                                                   
  (i) Amounts distributed to the beneficiary--                          
  Income currently distributed to the beneficiary                       
   (40% of $7,000)................................     $2,800           
  Other amounts distributed to the beneficiary                          
   (40% of $21,500)...............................      8,600           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary (40% of $1,500)....................        600           
                                                   -----------          
    Total amounts distributed to the beneficiary..     12,000           
  (ii) Amount of taxes imposed on the trust under                       
   chapter 1 of the Code attributable to the                            
   undistributed net income (See Sec.  1.665 (d)-                       
   1A) (40% of $1,500)............................        600           
                                                   -----------          
    Total....................................................     12,600
                                                   ------------         
    Undistributed net income.................................     11,400
                                                                        

    (c) Effect of prior distributions. The undistributed net income for 
any year to which an accumulation distribution for a later year may be 
thrown back will be reduced by accumulation distributions in intervening 
years that are required to be thrown back to such year. For example, if 
a trust has undistributed net income for 1975, and an accumulation 
distribution is made in 1980, there must be taken into account the 
effect on undistributed net income for 1975 of any accumulation 
distribution made in 1976, 1977, 1978, or 1979. However, undistributed 
net income for any year will not be reduced by any distributions in any 
intervening years that are excluded under section 663(a)(1), relating to 
gifts, bequests, etc. See paragraph (d) of Sec. 1.666(a)-1A for an 
illustration of the reduction of

[[Page 170]]

undistributed net income for any year by a subsequent accumulation 
distribution.
    (d) Distributions made in taxable years beginning before January 1, 
1974. For special rules relating to accumulation distributions of 
undistributed net income made in taxable years of the trust beginning 
before January 1, 1974, see Sec. 1.665(b)-2A.

[T.D. 7204, 37 FR 17136, Aug. 25, 1972]



Sec. 1.665(b)-1A   Accumulation distributions.

    (a) In general. (1) For any taxable year of a trust the term 
accumulation distribution means an amount by which the amounts properly 
paid, credited, or required to be distributed within the meaning of 
section 661(a)(2) (i.e., all amounts properly paid, credited, or 
required to be distributed to the beneficiary other than income required 
to be distributed currently within the meaning of section 661(a)(1)) for 
that year exceed the distributable net income (determined under section 
643(a)) of the trust, reduced (but not below zero) by the amount of 
income required to be distributed currently. To the extent provided in 
section 663(b) and the regulations thereunder, distributions made within 
the first 65 days following a taxable year may be treated as having been 
distributed on the last day of such taxable year.
    (2) An accumulation distribution also includes, for a taxable year 
of the trust, any amount to which section 661(a)(2) and the preceding 
paragraph are inapplicable and which is paid, credited, or required to 
be distributed during the taxable year of the trust by reason of the 
exercise of a power to appoint, distribute, consume, or withdraw corpus 
of the trust or income of the trust accumulated in a preceding taxable 
year. No accumulation distribution is deemed to be made solely because 
the grantor or any other person is treated as owner of a portion of the 
trust by reason of an unexercised power to appoint, distribute, consume, 
or withdraw corpus or accumulated income of the trust. Nor will an 
accumulation distribution be deemed to have been made by reason of the 
exercise of a power that may affect only taxable income previously 
attributed to the holders of such power under subpart E (section 671 and 
following). See example 4 of paragraph (d) of this section for an 
example of an accumulation distribution occurring as a result of the 
exercise of a power of withdrawal.
    (3) Although amounts properly paid or credited under section 661(a) 
do not exceed the income of the trust during the taxable year, an 
accumulation distribution may result if the amounts properly paid or 
credited under section 661(a)(2) exceed distributable net income reduced 
(but not below zero) by the amount required to be distributed currently 
under section 661(a)(1). This may occur, for example, when expenses, 
interest, taxes, or other items allocable to corpus are taken into 
account in determining taxable income and hence causing distributable 
net income to be less than the trust's income.
    (b) Payments that are accumulation distributions. The following are 
some instances in which an accumulation distribution may arise:
    (1) One trust to another. A distribution from one trust to another 
trust is generally an accumulation distribution. See Sec. 1.643(c)-1. 
This general rule will apply regardless of whether the distribution is 
to an existing trust or to a newly created trust and regardless of 
whether the trust to which the distribution is made was created by the 
same person who created the trust from which the distribution is made or 
a different person. However, a distribution made from one trust to a 
second trust will be deemed an accumulation distribution by the first 
trust to an ultimate beneficiary of the second trust if the primary 
purpose of the distribution to the second trust is to avoid the capital 
gain distribution provisions (see section 669 and the regulations 
thereunder). An amount passing from one separate share of a trust to 
another separate share of the same trust is not an accumulation 
distribution. See Sec. 1.665(g)-2A. For rules relating to the 
computation of the beneficiary's tax under section 668 by reason of an 
accumulation distribution from the second trust, see paragraphs (b)(1) 
and (c)(1)(i) of Sec. 1.668(b)-1A and paragraphs (b)(1) and (c)(1)(i) of 
Sec. 1.669(b)-1A.

[[Page 171]]

    (2) Income accumulated during minority. A distribution of income 
accumulated during the minority of the beneficiary is generally an 
accumulation distribution. For example, if a trust accumulates income 
until the beneficiary's 21st birthday, and then distributes the income 
to the beneficiary, such a distribution is an accumulation distribution. 
However, see Sec. 1.665(b)-2A for rules governing income accumulated in 
taxable years beginning before January 1, 1969.
    (3) Amounts paid for support. To the extent that amounts forming all 
or part of an accumulation distribution are applied or distributed for 
the support of a dependent under the circumstances specified in section 
677(b) or section 678(c) or are used to discharge or satisfy any 
person's legal obligation as that term is used in Sec. 1.662(a)-4, such 
amounts will be considered as having been distributed directly to the 
person whose obligation is being satisfied.
    (c) Payments that are not accumulation distributions--(1) Gifts, 
bequests, etc., described in section 663(a)(1). A gift or bequest of a 
specific sum of money or of specific property described in section 
663(a)(1) is not an accumulation distribution.
    (2) Charitable payments. Any amount paid, permanently set aside, or 
used for the purposes specified in section 642(c) is not an accumulation 
distribution, even though no charitable deduction is allowed under such 
section with respect to such payment.
    (3) Income required to be distributed currently. No accumulation 
distribution will arise by reason of a payment of income required to be 
distributed currently even though such income exceeds the distributable 
net income of the trust because the payment is an amount specified in 
section 661(a)(1).
    (d) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. A trustee properly makes a distribution to a beneficiary 
of $20,000 during the taxable year 1976, of which $10,000 is income 
required to be distributed currently to the beneficiary. The 
distributable net income of the trust is $15,000. There is an 
accumulation distribution of $5,000 computed as follows.

Total distribution...........................................    $20,000
Less: Income required to be distributed currently (section              
 661(a)(1))..................................................     10,000
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............     10,000
Distributable net income..........................    $15,000           
Less: Income required to be distributed currently.     10,000           
                                                   -----------          
Balance of distributable net income..........................      5,000
                                                   ------------         
    Accumulation distribution................................      5,000
                                                                        

    Example 2. Under the terms of the trust instrument, an annuity of 
$15,000 is required to be paid to A out of income each year and the 
trustee may in his discretion make distributions out of income or corpus 
to B. During the taxable year the trust had income of $18,000, as 
defined in section 643(b), and expenses allocable to corpus of $5,000. 
Distributable net income amounted to $13,000. The trustee distributed 
$15,000 of income to A and, in the exercise of his discretion, paid 
$5,000 to B. There is an accumulation distribution of $5,000 computed as 
follows:

Total distribution...........................................    $20,000
Less: Income required to be distributed currently to A                  
 (section 661(a)(1)).........................................     15,000
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............      5,000
Distributable net income..........................    $13,000           
Less: Income required to be distributed currently                       
 to A.............................................     15,000           
                                                   -----------          
Balance of distributable net income..........................          0
                                                   ------------         
    Accumulation distribution to B...........................      5,000
                                                                        

    Example 3. Under the terms of a trust instrument, the trustee may 
either accumulate the trust income or make distributions to A and B. The 
trustee may also invade corpus for the benefit of A and B. During the 
taxable year, the trust had income as defined in section 643(b) of 
$22,000 and expenses of $5,000 allocable to corpus. Distributable net 
income amounts to $17,000. The trustee distributed $10,000 each to A and 
B during the taxable year. There is an accumulation distribution of 
$3,000 computed as follows:

Total distribution...........................................    $20,000
Less: Income required to be distributed currently............          0
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............     20,000
Distributable net income..........................    $17,000           
Less: Income required to be distributed currently.          0           
                                                   -----------          
Balance of distributable net income..........................     17,000
                                                   ------------         
    Accumulation distribution................................      3,000
                                                                        

    Example 4. A dies in 1974 and bequeaths one-half the residue of his 
estate in trust. His widow, W, is given a power, exercisable solely by 
her, to require the trustee to pay her each year of the trust $5,000 
from corpus.

[[Page 172]]

W's right to exercise such power was exercisable at any time during the 
year but was not cumulative, so that, upon her failure to exercise it 
before the end of any taxable year of the trust, her right as to that 
year lapsed. The trust's taxable year is the calendar year. During the 
calendar years 1975 and 1976, W did not exercise her right and it lapsed 
as to those years. In the calendar years 1977 and 1978, in which years 
the trust had not distributable net income, she exercised her right and 
withdrew $4,000 in 1977 and $5,000 in 1978. No accumulation distribution 
was made by the trust in the calendar years 1975 and 1976. An 
accumulation distribution of $4,000 was made in 1977 and an accumulation 
distribution of $5,000 was made in 1978. The accumulation distribution 
for the years 1977 and 1978 is not reduced by any amount of income of 
the trust attributable to her under section 678 by reason of her power 
of withdrawal.

[T.D. 7204, 37 FR 17137, Aug. 25, 1972]



Sec. 1.665(b)-2A  Special rules for accumulation distributions made in taxable years beginning before January 1, 1974.

    (a) General rule. Section 331(d)(2)(A) of the Tax Reform Act of 1969 
excludes certain accumulated income from the tax imposed by section 
668(a)(2) by providing certain exceptions from the definition of an 
``accumulation distribution.'' Any amount paid, credited, or required to 
be distributed by a trust (other than a foreign trust created by a U.S. 
person) during a taxable year of the trust beginning after December 31, 
1968, and before January 1, 1974, shall not be subject to the tax 
imposed by section 668(a)(2) to the extent of the portion of such amount 
that (1) would be allocated under section 666(a) to a preceding taxable 
year of the trust beginning before January 1, 1969, and (2) would not 
have been deemed an accumulation distribution because of the provisions 
of paragraphs (1), (2), (3), or (4) of section 665(b) as in effect on 
December 31, 1968, had the trust distributed such amounts on the last 
day of its last taxable year beginning before January 1, 1969. However, 
the $2,000 de minimis exception formerly in section 665(b) does not 
apply in the case of any distribution made in a taxable year of a trust 
beginning after December 31, 1968. Amounts to which this exclusion 
applies shall reduce the undistributed net income of the trust for the 
preceding taxable year or years to which such amounts would be allocated 
under section 666(a). However, since section 668(a)(2) does not apply to 
such amounts, no amount of taxes imposed on the trust allocable to such 
undistributed net income is deemed distributed under section 666 (b) and 
(c).
    (b) Application of general rule. The rule expressed in paragraph (a) 
of this section is applied to the exceptions formerly in section 665(b) 
as follows:
    (1) Distributions from amounts accumulated while beneficiary is 
under 21. (i) Paragraph (1) of section 665(b) as in effect on December 
31, 1968, provided that amounts paid, credited, or required to be 
distributed to a beneficiary as income accumulated before the birth of 
such beneficiary or before such beneficiary attains the age of 21 were 
not to be considered to be accumulation distributions. If an 
accumulation distribution is made in a taxable year of the trust 
beginning after December 31, 1968, and before January 1, 1974, and under 
section 666(a) such accumulation distribution would be allocated to a 
preceding taxable year beginning before January 1, 1969, no tax shall be 
imposed under section 668(a)(2) to the extent the income earned by the 
trust for such preceding taxable year would be deemed under 
Sec. 1.665(b)-2(b)(1) to have been accumulated before the beneficiary's 
birth or before his 21st birthday. The provisions of this subparagraph 
may be illustrated by the following example:

    Example. A trust on the calendar year basis was established on 
January 1, 1965, to accumulate the income during the minority of B, and 
to pay the accumulated income over to B upon his attaining the age of 
21. B's 21st birthday is January 1, 1973. On January 2, 1973, the 
trustee pays over to B all the accumulated income of the trust. The 
distribution is an accumulation distribution that may be allocated under 
section 666(a) to 1968, 1969, 1970, 1971, and 1972 (the 5 preceding 
taxable years as defined in Sec. 1.665(e)-1A). To the extent the 
distribution is allocated to 1968, no tax is imposed under section 
668(a)(2).

    (ii) As indicated in paragraph (a) of this section, a distribution 
of an amount excepted from the tax otherwise imposed under section 
668(a)(2) will reduce undistributed net income for the purpose of 
determining the effect of a future distribution. Thus,

[[Page 173]]

under the facts of the example in subdivision (i) of this subparagraph, 
the undistributed net income for the trust's taxable year 1968 would be 
reduced by the amount of the distribution allocated to that year under 
section 666(a).
    (2) Emergency distributions. Paragraph (2) of section 665(b) as in 
effect on December 31, 1968, provided an exclusion from the definition 
of an accumulation distribution for amounts properly paid or credited to 
a beneficiary to meet his emergency needs. Therefore, if an accumulation 
distribution is made from a trust in a taxable year beginning before 
January 1, 1974, and under section 666(a) such accumulation distribution 
would be allocated to a preceding taxable year of the trust beginning 
before January 1, 1969, no tax shall be imposed under section 668(a)(2) 
if such distribution would have been considered an emergency 
distribution under Sec. 1.665(b)-2(b)(2) had it been made in a taxable 
year of the trust beginning before January 1, 1969. For example, assume 
a trust on a calendar year basis in 1972 makes an accumulation 
distribution which under Sec. 1.665(b)-2(b) (2) would be considered an 
emergency distribution and under section 666(a) the distribution would 
be allocated to the years 1967, 1968, and 1969. To the extent such 
amount is allocated to 1967 and 1968, no tax would be imposed under 
section 668(a)(2).
    (3) Certain distributions at specified ages. Paragraph (3) of 
section 665(b) as in effect on December 31, 1968, provided an exclusion 
(in the case of certain trusts created before January 1, 1954) from the 
definition of an accumulation distribution for amounts properly paid or 
credited to a beneficiary upon his attaining a specified age or ages, 
subject to certain restrictions (see Sec. 1.665(b)-2(b)(3)). Therefore, 
a distribution from a trust in a taxable year beginning after December 
31, 1968, will not be subject to the tax imposed under section 668(a)(2) 
to the extent such distribution would be allocated to a preceding 
taxable year of the trust beginning before January 1, 1969, if such 
distribution would have qualified under the provisions of Sec. 1.665(b)-
2(b)(3) had it been made in a taxable year of the trust to which such 
section was applicable.
    (4) Certain final distributions. Paragraph (4) of section 665(b) as 
in effect on December 31, 1968, provided an exclusion from the 
definition of an accumulation distribution for amounts properly paid or 
credited to a beneficiary as a final distribution of the trust if such 
final distribution was made more than 9 years after the date of the last 
transfer to such trust. Therefore, amounts properly paid or credited to 
a beneficiary as a final distribution of a trust in a taxable year of a 
trust beginning after December 31, 1968, and before January 1, 1974, 
will not be subject to the tax imposed under section 668(a)(2) to the 
extent such distribution would be allocated to a preceding taxable year 
of the trust beginning before January 1, 1969, if such final 
distribution was made more than 9 years after the date of the last 
transfer to such trust. The provisions of this subparagraph may be 
illustrated by the following example:

    Example. A trust on a calendar year basis was established on January 
1, 1958, and no additional transfers were made to it. On January 1, 
1973, the trustee terminates the trust and on the same day he makes a 
final distribution to the beneficiary, B. The distribution is an 
accumulation distribution that may be allocated under section 666(a) to 
1968, 1969, 1970, 1971, and 1972 (the 5 preceding taxable years as 
defined in Sec. 1.665(e)-1A). Because more than 9 years elapsed between 
the date of the last transfer to the trust and the date of final 
distribution, the distribution is not taxed under section 668 (a) (2) to 
the extent it would be allocated to 1968 under section 666(a).

[T.D. 7204, 37 FR 17138, Aug. 25, 1972]



Sec. 1.665(c)-1A   Special rule applicable to distributions by certain foreign trusts.

    (a) In general. Except as provided in paragraph (b) of this section, 
for purposes of section 665 any amount paid to a U.S. person which is 
from a payor who is not a U.S. person and which is derived directly or 
indirectly from a foreign trust created by a U.S. person shall be deemed 
in the year of payment to the U.S. person to have been directly paid to 
the U.S. person by the trust. For example, if a nonresident

[[Page 174]]

alien receives a distribution from a foreign trust created by a U.S. 
person and then pays the amount of the distribution over to a U.S. 
person, the payment of such amount to the U.S. person represents an 
accumulation distribution to the U.S. person from the trust to the 
extent that the amount received would have been an accumulation 
distribution had the trust paid the amount directly to the U.S. person 
in the year in which the payment was received by the U.S. person. This 
section also applies in a case where a nonresident alien receives 
indirectly an accumulation distribution from a foreign trust created by 
a U.S. person and then pays it over to a U.S. person. An example of such 
a transaction is one where the foreign trust created by a U.S. person 
makes the distribution to an intervening foreign trust created by either 
a U.S. person or a person other than a U.S. person and the intervening 
trust distributes the amount received to a nonresident alien who in turn 
pays it over to a U.S. person. Under these circumstances, it is deemed 
that the payment received by the U.S. person was received directly from 
a foreign trust created by a U.S. person.
    (b) Limitation. In the case of a distribution to a beneficiary who 
is a U.S. person, paragraph (a) of this section does not apply if the 
distribution is received by such beneficiary under circumstances 
indicating lack of intent on the part of the parties to circumvent the 
purposes for which section 7 of the Revenue Act of 1962 (76 Stat. 985) 
was enacted.

[T.D. 7204, 37 FR 17139 Aug. 25, 1972]



Sec. 1.665(d)-1A   Taxes imposed on the trust.

    (a) In general. (1) For purposes of subpart D, the term taxes 
imposed on the trust means the amount of Federal income taxes properly 
imposed for any taxable year on the trust that are attributable to the 
undistributed portions of distributable net income and gains in excess 
of losses from the sales or exchanges of capital assets. Except as 
provided in paragraph (c)(2) of this section, the minimum tax for tax 
preferences imposed by section 56 is not a tax attributable to the 
undistributed portions of distributable net income and gains in excess 
of losses from the sales or exchanges of capital assets. See section 56 
and the regulations thereunder.
    (2) In the case of a trust that has received an accumulation 
distribution from another trust, the term taxes imposed on the trust 
also includes the amount of taxes deemed distributed under 
Secs. 1.666(b)-1A, 1.666(c)-1A, 1.669(d)-1A, and 1.669(e)-1A (whichever 
are applicable) as a result of such accumulation distribution, to the 
extent that they were taken into account under paragraphs (b)(2) or 
(c)(1)(vi) of Sec. 1.668 (b)-1A and (b)(2) or (c)(1)(vi) of 
Sec. 1.669(b)-1A in computing the partial tax on such accumulation 
distribution. For example, assume that trust A, a calendar year trust, 
makes an accumulation distribution in 1975 to trust B, also on the 
calendar year basis, in connection with which $500 of taxes are deemed 
under Sec. 1.666(b)-1A to be distributed to trust B. The partial tax on 
the accumulation distribution is computed under paragraph (b) of 
Sec. 1.668(b)-1A (the exact method) to be $600 and all of the $500 is 
used under paragraph (b)(2) of Sec. 1.668(b)-1A to reduce the partial 
tax to $100. The taxes imposed on trust B for 1975 will, in addition to 
the $100 partial tax, also include the $500 used to reduce the partial 
tax.
    (b) Taxes imposed on the trust attributable to undistributed net 
income. (1) For the purpose of subpart D, the term taxes imposed on the 
trust attributable to the undistributed net income means the amount of 
Federal income taxes for the taxable year properly allocable to the 
undistributed portion of the distributable net income for such taxable 
year. This amount is (i) an amount that bears the same relationship to 
the total taxes of the trust for the year (other than the minimum tax 
for tax preferences imposed by section 56), computed after the allowance 
of credits under section 642(a), as (a) the taxable income of the trust, 
other than the capital gains not included in distributable net income 
less their share of section 1202 deduction, bears to (b) the total 
taxable income of the trust for such year or, (ii) if the alternative 
tax computation under section 1201(b) is used and there are no net 
short-term gains, an amount equal to such total

[[Page 175]]

taxes less the amount of the alternative tax imposed on the trust and 
attributable to the capital gain. Thus, for the purposes of subpart D, 
in determining the amount of taxes imposed on the trust attributable to 
the undistributed net income, that portion of the taxes paid by the 
trust attributable to capital gain allocable to corpus is excluded. The 
rule stated in this subparagraph may be illustrated by the following 
example, which assumes that the alternative tax computation is not used:

    Example. (1) Under the terms of a trust, which reports on the 
calendar year basis, the income may be accumulated or distributed to A 
in the discretion of the trustee and capital gains are allocable to 
corpus. During the taxable year 1974, the trust had income of $20,000 
from royalties, long-term capital gains of $10,000, and expenses of 
$2,000. The trustee in his discretion made a distribution of $10,000 to 
A. The taxes imposed on the trust for such year attributable to the 
undistributed net income are $2,319, determined as shown below.
    (2) The distributable net income of the trust computed under section 
643(a) is $18,000 (royalties of $20,000 less expenses of $2,000). The 
total taxes paid by the trust are $3,787, computed as follows:

Royalties....................................................    $20,000
Capital gain allocable to corpus.............................     10,000
                                                   ------------         
    Gross income.............................................     30,000
Deductions:                                                             
  Expenses........................................     $2,000           
  Distributions to A..............................     10,000           
  Capital gain deduction..........................      5,000           
  Personal exemption..............................        100           
                                                   -----------          
                                                                  17,100
                                                   ------------         
Taxable income...............................................     12,900
    Total income taxes.......................................      3,787
                                                                        

    (3) Taxable income other than capital gains less the section 1202 
deduction is $7,900 ($12,900-($10,000-$5,000)). Therefore, the amount of 
taxes imposed on the trust attributable to the undistributed net income 
is $2,319, computed as follows:

$3,787 (total taxes)  x  $7,900 (taxable income other than              
 capital gains not included in d.n.i. less the 1202                     
 deduction) divided by $12,900 (taxable income)..............     $2,319
                                                                        

    (2) If in any taxable year an accumulation distribution of 
undistributed net income is made by the trust which results in a 
throwback to a prior year, the taxes of the prior year imposed on the 
trust attributable to any remaining undistributed net income of such 
prior year are the taxes prescribed in subparagraph (1) of this 
paragraph reduced by the taxes of the prior year deemed distributed 
under section 666 (b) or (c). The provisions of this subparagraph may be 
illustrated by the following example:

    Example. Assume the same facts as in the example in subparagraph (1) 
of this paragraph. In 1975 the trust makes an accumulation distribution, 
of which an amount of undistributed net income is deemed distributed in 
1974. Taxes imposed on the trust (in the amount of $1,000) attributable 
to the undistributed net income are therefore deemed distributed in such 
year. Consequently, the taxes imposed on the trust subsequent to the 
1975 distribution attributable to the remaining undistributed net income 
are $1,319 ($2,319 less $1,000).

    (c) Taxes imposed on the trust attributable to undistributed capital 
gain--(1) Regular tax. For the purpose of subpart D the term taxes 
imposed on the trust attributable to undistributed capital gain means 
the amount of Federal income taxes for the taxable year properly 
attributable to that portion of the excess of capital gains over capital 
losses of the trust that is allocable to corpus for such taxable year. 
Such amount is the total of:
    (i) The amount computed under subparagraph (2) of this paragraph 
(the minimum tax), plus
    (ii) The amount that bears the same relationship to the total taxes 
of the trust for the year (other than the minimum tax), computed after 
the allowance of credits under section 642(a), as (a) the excess of 
capital gains over capital losses for such year that are not included in 
distributable net income, computed after its share of the deduction 
under section 1202 (relating to the deduction for capital gains) has 
been taken into account, bears to the greater of (b) the total taxable 
income of the trust for such year, or (c) the amount of capital gains 
computed under (a) of this subdivision.

However, if the alternative tax computation under section 1201(b) is 
used and there are no net short-term gains, the amount is the amount of 
the alternative tax imposed on the trust and attributable to the capital 
gain. The application of this subparagraph may be illustrated by the 
following example,

[[Page 176]]

which assumes that the alternative tax computation is not used:

    Example. Assume the same facts as in the example in paragraph 
(b)(1). The capital gains not included in d.n.i. are $10,000, and the 
deduction under section 1202 is $5,000. The amount of taxes imposed on 
the trust attributable to undistributed capital gain is $1,468, computed 
as follows:

$3,787 (total taxes)  x  $5,000 (capital gains not included             
 in d.n.i. less section 1202 deductions) divided by $12,900             
 (taxable income)............................................     $1,468
                                                                        

    (2) Minimum tax. The term taxes imposed on the trust attributable to 
the undistributed capital gain also includes the minimum tax for tax 
preferences imposed on the trust by section 56 with respect to the 
undistributed capital gain. The amount of such minimum tax so included 
bears the same relation to the total amount of minimum tax imposed on 
the trust by section 56 for the taxable year as one-half the net capital 
gain (net section 1201 gain for taxable years beginning before January 
1, 1977) (as defined in section 1222(11)) from such taxable year bears 
to the sum of the items of tax preference of the trust for such taxable 
year which are apportioned to the trust in accordance with Sec. 1.58-
3(a) (1).
    (3) Reduction for prior distribution. If in any taxable year a 
capital gain distribution is made by the trust which results in a 
throwback to a prior year, the taxes of the prior year imposed on the 
trust attributable to any remaining undistributed capital gain of the 
prior year are the taxes prescribed in subparagraph (1) of this 
paragraph reduced by the taxes of the prior year deemed distributed 
under section 669 (d) or (e). The provisions of this subparagraph may be 
illustrated by the following example:

    Example. Assume the same facts as in the example in subparagraph (1) 
of this paragraph. In 1976, the trust makes a capital gain distribution, 
of which an amount of undistributed capital gain is deemed distributed 
in 1974. Taxes imposed on the trust (in the amount of $500) attributable 
to the undistributed capital gain are therefore deemed distributed in 
such year. Consequently, the taxes imposed on the trust attributable to 
the remaining undistributed capital gain are $968 ($1,468 less $500).

[T.D. 7204, 37 FR 17139, Aug. 25, 1972, as amended by T.D. 7728, 45 FR 
72650, Nov. 3, 1980]



Sec. 1.665(e)-1A   Preceding taxable year.

    (a) Definition--(1) Domestic trusts-- (i) In general. For purposes 
of subpart D, in the case of a trust other than a foreign trust created 
by a U.S. person, the term preceding taxable year serves to identify and 
limit the taxable years of a trust to which an accumulation distribution 
consisting of undistributed net income or undistributed capital gain may 
be allocated (or ``thrown back'') under section 666(a) and 669(a). An 
accumulation distribution consisting of undistributed net income or 
undistributed capital gain may not be allocated or ``thrown back'' to a 
taxable year of a trust if such year is not a ``preceding taxable 
year.''
    (ii) Accumulation distributions. In the case of an accumulation 
distribution consisting of undistributed net income made in a taxable 
year beginning before January 1, 1974, any taxable year of the trust 
that precedes by more than 5 years the taxable year of the trust in 
which such accumulation distribution was made is not a ``preceding 
taxable year.'' Thus, for a domestic trust on a calendar year basis, 
calendar year 1967 is not a ``preceding taxable year'' with respect to 
an accumulation distribution made in calendar year 1973, whereas 
calendar year 1968 is a ``preceding taxable year.'' In the case of an 
accumulation distribution made during a taxable year beginning after 
December 31, 1973, any taxable year of the trust that begins before 
January 1, 1969, is not a ``preceding taxable year.'' Thus, for a 
domestic trust on a calendar year basis, calendar year 1968 is not a 
``preceding taxable year'' with respect to an accumulation distribution 
made in calendar year 1975, whereas calendar year 1969 is a ``preceding 
taxable year.''
    (iii) Capital gain distributions. In the case of an accumulation 
distribution that is a capital gain distribution, any taxable year of 
the trust that (a) begins before January 1, 1969, or (b) is prior to the 
first year in which income is accumulated, whichever occurs later, is 
not a ``preceding taxable year.'' Thus, for the purpose of capital gain 
distributions and section 669, only taxable years beginning after 
December 31, 1968, can be ``preceding taxable years.'' See 
Sec. 1.688(a)-1A(c).

[[Page 177]]

    (2) Foreign trusts created by U.S. persons. For purposes of subpart 
D, in the case of a foreign trust created by a U.S. person, the term 
``preceding taxable year'' does not include any taxable year to which 
part I of subchapter J does not apply. See section 683 and regulations 
thereunder. Accordingly, the provisions of subpart D may not, in the 
case of a foreign trust created by a U.S. person, be applied to any 
taxable year which begins before 1954 or ends before August 17, 1954. 
For example, if a foreign trust created by a U.S. person (reporting on 
the calendar year basis) makes a distribution during the calendar year 
1970 of income accumulated during prior years, the earliest year of the 
trust to which the accumulation distribution may be allocated under such 
subpart D is 1954, but it may not be allocated to 1953 and prior years, 
since the Internal Revenue Code of 1939 applies to those years.
    (b) Simple trusts. A taxable year of a trust during which the trust 
was a simple trust (that is, was subject to subpart B) for the entire 
year shall not be considered a ``preceding taxable year'' unless during 
such year the trust received ``outside income'' or unless the trustee 
did not distribute all of the income of the trust that was required to 
be distributed currently for such year. In such event, undistributed net 
income for such year shall not exceed the greater of the ``outside 
income'' or income not distributed during such year. For purposes of 
this paragraph, the term outside income means amounts that are included 
in distributable net income of the trust for the year but that are not 
``income'' of the trust as that term is defined in Sec. 1.643(b)-1. Some 
examples of ``outside income'' are:
    (1) Income taxable to the trust under section 691;
    (2) Unrealized accounts receivable that were assigned to the trust; 
and
    (3) Distributions from another trust that include distributable net 
income or undistributed net income of such other trust.

The term outside income, however, does not include amounts received as 
distributions from an estate, other than income specified in (1) and 
(2), for which the estate was allowed a deduction under section 661(a). 
The application of this paragraph may be illustrated by the following 
examples:

    Example 1. By his will D creates a trust for his widow W. The terms 
of the trust require that the income be distributed currently (i.e., it 
is a simple trust), and authorize the trustee to make discretionary 
payments of corpus to W. Upon W's death the trust corpus is to be 
distributed to D's then living issue. The executor of D's will makes a 
$10,000 distribution of corpus to the trust that carries out estate 
income consisting of dividends and interest to the trust under section 
662(a)(2). The trust reports this income as its only income on its 
income tax return for its taxable year in which ends the taxable year of 
the estate in which the $10,000 distribution was made, and pays a tax 
thereon of $2,106. Thus, the trust has undistributed net income of 
$7,894 ($10,000 -$2,106). Several years later the trustee makes a 
discretionary corpus payment of $15,000 to W. This payment is an 
accumulation distribution under section 665(b). However, since the trust 
had no ``outside income'' in the year of the estate distribution, such 
year is not a preceding taxable year. Thus, W is not treated as 
receiving undistributed net income of $7,894 and taxes thereon of $2,106 
for the purpose of including the same in her gross income under section 
668. The result would be the same if the invasion power were not 
exercised and the accumulation distribution occurred as a result of the 
distribution of the corpus to D's issue upon the death of W.
    Example 2. Trust A, a simple trust on the calendar year basis, 
received in 1972 extraordinary dividends or taxable stock dividends that 
the trustee in good faith allocated to corpus, but that are determined 
in 1974 to have been currently distributable to the beneficiary. See 
section 643(a)(4) and Sec. 1.643(a)-4. Trust A would qualify for 
treatment under subpart C for 1974, the year of distribution of the 
extraordinary dividends or taxable stock dividends, because the 
distribution is not out of income of the current taxable year and is 
treated as another amount properly paid or credited or required to be 
distributed for such taxable year within the meaning of section 661(a) 
(2). Also, the distribution in 1974 qualifies as an accumulation 
distribution for the purposes of subpart D. For purposes only of such 
subpart D, trust A would be treated as subject to the provisions of such 
subpart C for 1972, the preceding taxable year in which the 
extraordinary or taxable stock dividends were received, and, in 
computing undistributed net income for 1972, the extraordinary or 
taxable stock dividends would be included in distributable net income 
under section 643(a). The rule stated in the preceding sentence would 
also apply if the distribution in 1974 was made out of corpus without 
regard to a determination that the

[[Page 178]]

extraordinary dividends or taxable stock dividends in question were 
currently distributable to the beneficiary.

[T.D. 7204, 37 FR 17141, Aug. 25, 1972]



Sec. 1.665(f)-1A   Undistributed capital gain.

    (a) Domestic trusts. (1) The term undistributed capital gain means 
(in the case of a trust other than a foreign trust created by a U.S. 
person), for any taxable year of the trust beginning after December 31, 
1968, the gains in excess of losses for that year from the sale or 
exchange of capital assets of the trust less:
    (i) The amount of such gains that are included in distributable net 
income under section 643(a)(3) and Sec. 1.643(a)-3.
    (ii) The amount of taxes imposed on the trust for such year 
attributable to such gains, as defined in Sec. 1.665(d)-1A, and
    (iii) In the case of a trust that does not use the alternative 
method for computing taxes on capital gains of the taxable year, the 
excess of deductions (other than deductions allowed under section 642(b) 
relating to personal exemption or section 642(c) relating to charitable 
contributions) over distributable net income for such year to the extent 
such excess deductions are properly allowable in determining taxable 
income for such year.

For purposes of computing the amount of capital gain under this 
paragraph, no deduction under section 1202, relating to deduction for 
excess of capital gains over capital losses, shall be taken into 
account. The application of this subparagraph may be illustrated by the 
following example:

    Example. Under the terms of the trust, the trustee must distribute 
all income currently and has discretion to distribute capital gain to A 
or to allocate it to corpus. During the taxable year 1971 the trust 
recognized capital gain in the amount of $15,000, and capital losses of 
$5,000, and had interest income (after expenses) of $6,000. The trustee 
distributed $8,000 to A, consisting of $6,000 of interest and $2,000 of 
capital gain. The $2,000 of gain distributed to A is included in the 
computation of distributable net income under Sec. 1.643(a)-3. The 
balance of the capital gain is not included in distributable net income 
since it is allocated to corpus and not paid, credited, or required to 
be distributed to any beneficiary. The trust paid taxes of $671, all of 
which are attributable under Sec. 1.665(d)-1A to the undistributed 
capital gain. The amount of undistributed capital gain of the trust for 
1971 is therefore $7,329, computed as follows:

Total capital gains..........................................    $15,000
Less: Capital losses.........................................      5,000
                                                   ------------         
Gains in excess of losses....................................     10,000
                                                   ============         
Less:                                                                   
Amount of capital gain included in distributable net income..      2,000
  Taxes imposed on the trust attributable to the                        
   undistributed capital gain (see Sec.  1.665(d)-1A)........        671
                                                   ------------         
                                                                   2,671
                                                   ------------         
Undistributed capital gain...................................      7,329
                                                   ============         
                                                                        

    (2) For purposes of subparagraph (1) of this paragraph, the term 
losses for that year includes losses of the trusts from the sale or 
exchange of capital assets in preceding taxable years not included in 
the computation of distributable net income of any year, reduced by such 
losses taken into account in a subsequent preceding taxable year in 
computing undistributed capital gain but not reduced by such losses 
taken into account in determining the deduction under section 1211. See 
section 1212(b)(2) and the regulations thereunder. For example, assume 
that a trust had a net long-term capital loss in 1970 of $5,000. During 
the years 1971 through 1975, the trust had no capital gains or capital 
losses. In 1976, it has a long-term capital gain of $8,000, which it 
allocates to corpus and does not distribute to a beneficiary, but has no 
taxes attributable to such gain. The undistributed capital gain for 1976 
is $8,000-$5,000, or $3,000, even though all or a part of the $5,000 
loss was claimed under section 1211 as a deduction in years 1970 through 
1975.
    (b) Foreign trusts. Distributable net income for a taxable year of a 
foreign trust created by a U.S. person includes capital gains in excess 
of capital losses for such year (see Sec. 1.643(a)-6(a)(3)). Thus, a 
foreign trust created by a U.S. person can never have any undistributed 
capital gain.

[T.D. 7204, 37 FR 17142, Aug. 25, 1972]



Sec. 1.665(g)-1A   Capital gain distribution.

    For any taxable year of a trust, the term capital gain distribution 
means, to

[[Page 179]]

the extent of the undistributed capital gain of the trust, that portion 
of an accumulation distribution that exceeds the amount of such 
accumulation distribution deemed under section 666(a) to be 
undistributed net income of the trust for all preceding taxable years. 
See Sec. 1.665(b)-1A for the definition of ``accumulation 
distribution''. For any such taxable year the undistributed capital gain 
includes the total undistributed capital gain for all years of the trust 
beginning with the first taxable year beginning after December 31, 1968, 
in which income (as determined under section 643(b)) is accumulated, and 
ending before such taxable year. See Sec. 1.665(g)-2A for application of 
the separate share rule. The application of this section may be 
illustrated by the following example:

    Example. A trust on the calendar year basis made the following 
accumulations. For purposes of this example, the undistributed net 
income is the same as income under applicable local law. No income was 
accumulated prior to 1970.

------------------------------------------------------------------------
                                        Undistributed     Undistributed 
                Year                     net income       capital gain  
------------------------------------------------------------------------
1969................................         None           $10,000     
1970................................       $1,000             3,000     
1971................................         None             4,000     
------------------------------------------------------------------------

    The trust has distributable net income in 1972 of $2,000 and 
recognizes capital gains of $4,500 that are allocable to corpus. On 
December 31, 1972, the trustee makes a distribution of $20,000 to the 
beneficiary. There is an accumulation distribution of $18,000 $20,000 
distribution less $2,000 d.n.i.) that consists of undistributed net 
income of $1,000 (see Sec. 1.666(a)-1A) and a capital gain distribution 
of $7,000. The capital gain distribution is computed as follows:

Accumulation distribution....................................    $18,000
Less: Undistributed net income...............................      1,000
                                                              ----------
    Balance..................................................     17,000
                                                              ==========
Capital gain distribution (undistributed capital gain of the            
 trust for 1972 ($3,000 from 1970 and $4,000 from 1971)).....      7,000
                                                              ----------
    Balance (corpus).........................................     10,000
                                                                        

No undistributed capital gain is deemed distributed from 1969 because 
1969 is a year prior to the first year in which income is accumulated 
(1970). The accumulation distribution is not deemed to consist of any 
part of the capital gains recognized in 1972.

[T.D. 7204, 37 FR 17142, Aug. 25, 1972]



Sec. 1.665(g)-2A   Application of separate share rule.

    (a) In general. If the separate share rule of section 663(c) is 
applicable for any taxable year of a trust, subpart D is applied as if 
each share were a separate trust except as provided in paragraph (c) of 
this section and in Sec. 1.668(a)-1A(c). Thus, the amounts of an 
``accumulation distribution'', ``undistributed net income'', 
``undistributed capital gain'', and ``capital gain distribution'' are 
computed separately for each share.
    (b) Allocation of taxes--undistributed net income. The ``taxes 
imposed on the trust attributable to the undistributed net income'' are 
allocated as follows:
    (1) There is first allocated to each separate share that portion of 
the ``taxes imposed on the trust attributable to the undistributed net 
income'' (as defined in Sec. 1.665(d)-1A(b)), computed before the 
allowance of any credits under section 642(a), that bears the same 
relation to the total of such taxes that the distributable net income of 
the separate share bears to the distributable net income of the trust, 
adjusted for this purpose as follows:
    (i) There is excluded from distributable net income of the trust and 
of each separate share any tax-exempt interest, foreign income of a 
foreign trust, and excluded dividends, to the extent such amounts are 
included in distributable net income pursuant to section 643(a) (5), 
(6), and (7); and
    (ii) The distributable net income of the trust is reduced by any 
deductions allowable under section 661 for amounts paid, credited, or 
required to be distributed during the taxable year, and the 
distributable net income of each separate share is reduced by any such 
deduction allocable to that share.
    (2) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed on the trust'' that 
bears the same relation to the total of such credits that the items of 
distributable net income allocable to the separate share with respect to 
which the credit is allowed bear to the total of such items of the 
trust.

[[Page 180]]

    (c) Allocation of taxes--undistributed capital gain. The ``taxes 
imposed on the trust attributable to undistributed capital gain'' are 
allocated as follows:
    (1) There is first allocated to each separate share that portion of 
the ``taxes imposed on the trust attributable to undistributed capital 
gain'' (as defined in Sec. 1.665(d)-1A(c)), computed before the 
allowance of any credits under section 642(a), that bears the same 
relation to the total of such taxes that the undistributed capital gain 
(prior to the deduction of taxes under section 665(c)(2)) of the 
separate share bears to the total such undistributed capital gain of the 
trust.
    (2) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed on the trust'' that 
bears the same relation to the total of such credits that the capital 
gain allocable to the separate share with respect to which the credit is 
allowed bear to the total of such capital gain of the trust.
    (d) Termination of a separate share. (1) If upon termination of a 
separate share, an amount is properly paid, credited, or required to be 
distributed by the trust under section 661(a)(2) to a beneficiary from 
such share, an accumulation distribution will be deemed to have been 
made to the extent of such amount. In determining the distributable net 
income of such share, only those items of income and deduction for the 
taxable year of the trust in which such share terminates, properly 
allocable to such share, shall be taken into consideration.
    (2) No accumulation distribution will be deemed to have been made 
upon the termination of a separate share to the extent that the property 
constituting such share, or a portion thereof, continues to be held as a 
part of the same trust. The undistributed net income, undistributed 
capital gain, and the taxes imposed on the trust attributable to such 
items, if any, for all preceding taxable years (reduced by any amounts 
deemed distributed under sections 666(a) and 669(a) by reason of any 
accumulation distribution of undistributed net income or undistributed 
capital gain in prior years or the current taxable year), which were 
allocable to the terminating share, shall be treated as being applicable 
to the trust itself. However, no adjustment will be made to the amounts 
deemed distributed under sections 666 and 669 by reason of an 
accumulation distribution of undistributed net income or undistributed 
capital gain from the surviving share or shares made in years prior to 
the year in which the terminating share was added to such surviving 
share or shares.
    (3) The provisions of this paragraph may be illustrated by the 
following example:

    Example. A trust was established under the will of X for the benefit 
of his wife and upon her death the property was to continue in the same 
trust for his two sons, Y and Z. The separate share rule is applicable 
to this trust. The trustee had discretion to pay or accumulate the 
income to the wife, and after her death was to pay each son's share to 
him after he attained the age of 25. When the wife died, Y was 23 and Z 
was 28.
    (1) Upon the death of X's widow, there is no accumulation 
distribution. The entire trust is split into two equal shares, and 
therefore the undistributed net income and the undistributed capital 
gain of the trust are split into two shares.
    (2) The distribution to Z of his share after his mother's death is 
an accumulation distribution of his separate share of one-half of the 
undistributed net income and undistributed capital gain.

[T.D. 7204, 37 FR 17142, Aug. 25, 1972]

Treatment of Excess Distributions of Trusts Applicable to Taxable Years 
                    Beginning Before January 1, 1969



Sec. 1.665(a)-0  Excess distributions by trusts; scope of subpart D.

    Subpart D (section 665 and following), part I, subchapter J, chapter 
1 of the Internal Revenue Code, in the case of trusts other than foreign 
trusts created by U.S. persons, is designed generally to prevent a shift 
of tax burden to a trust from a beneficiary or beneficiaries. In the 
case of a foreign trust created by a U.S. person, subpart D is designed 
to prevent certain other tax avoidance possibilities. To accomplish 
these ends, subpart D provides special rules for treatment of amounts 
paid, credited, or required to be distributed by a complex trust 
(subject to subpart

[[Page 181]]

C (section 661 and following) of such part I) in any year in excess of 
distributable net income for that year. Such an excess distribution is 
defined as an accumulation distribution, subject to the limitations in 
section 665 (b) or (c). An accumulation distribution, in the case of a 
trust other than a foreign trust created by a U.S. person, is ``thrown 
back'' to each of the 5 preceding years in inverse order. In the case of 
a foreign trust created by a U.S. person such an accumulation 
distribution is ``thrown back,'' in inverse order, to each of the 
preceding years to which the Internal Revenue Code of 1954 applies. That 
is, an accumulation distribution will be taxed to the beneficiaries of 
the trust in the year the distribution is made or required, but, in 
general, only to the extent of the distributable net income of those 
years which was not in fact distributed. However, with respect to a 
distribution by a trust other than a foreign trust created by a U.S. 
person, the resulting tax will not be greater than the aggregate of the 
taxes that would have been attributable to the amount thrown back to 
previous years had they been included in gross income of the 
beneficiaries in those years. In the case of a foreign trust created by 
a U.S. person, the resulting tax is computed under the provisions of 
section 669. To prevent double taxation, both in the case of a foreign 
trust created by a U.S. person, and a trust other than a foreign trust 
created by a U.S. person, the beneficiaries receive a credit for any 
taxes previously paid by the trust which are attributable to the excess 
thrown back and which are creditable under the provisions of chapter 1 
of the Internal Revenue Code. Subpart D does not apply to any estate.

[T.D. 6989, 34 FR 733, Jan. 17, 1969]



Sec. 1.665(a)-1   Undistributed net income.

    (a) The term undistributed net income means for any taxable year the 
distributable net income of the trust for that year as determined under 
section 643(a), less:
    (1) The amount of income required to be distributed currently and 
any other amounts properly paid or credited or required to be 
distributed to beneficiaries in the taxable year as specified in 
paragraphs (1) and (2) of section 661(a), and
    (2) The amount of taxes imposed on the trust, as defined in 
Sec. 1.665(d)-1.
    The application of the rule in this paragraph to the first year of a 
trust in which income is accumulated may be illustrated by the following 
example:

    Example. Assume that under the terms of the trust, $10,000 of income 
is required to be distributed currently to A and the trustee has 
discretion to make additional distributions to A. During the taxable 
year 1954 the trust had distributable net income of $30,100 derived from 
royalties and the trustee made distributions of $20,000 to A. The 
taxable income of the trust is $10,000 on which a tax of $2,640 is paid. 
The undistributed net income of the trust as of the close of the taxable 
year 1954 is $7,460 computed as follows:

Distributable net income.....................................    $30,100
Less:                                                                   
  Income currently distributable to A.............    $10,000           
  Other amounts distributed to A..................     10,000           
  Taxes imposed on the trust (see Sec.  1.665(d)-                       
   1).............................................      2,640           
                                                   -----------          
                                                                  22,640
                                                   ------------         
    Undistributed net income.................................      7,460
                                                                        

See also paragraphs (e)(1) and (f)(1) of Sec. 1.668(b)-2 for additional 
illustrations of the application of the rule in this paragraph to the 
first year of a trust in which income is accumulated.

    (b) The undistributed net income of a foreign trust created by a 
U.S. person for any taxable year is the distributable net income of such 
trust (see Sec. 1.643(a)-6 and the examples set forth in paragraph (b) 
thereof), less:
    (1) The amount of income required to be distributed currently and 
any other amounts properly paid or credited or required to be 
distributed to beneficiaries in the taxable year as specified in 
paragraphs (1) and (2) of section 661(a), and
    (2) The amount of taxes imposed on such trust by chapter 1 of the 
Internal Revenue Code, which are attributable to items of income which 
are required to be included in such distributable net income. For 
purposes of subparagraph (2) of this paragraph, the amount of taxes 
imposed on the trust (for any taxable year), by chapter 1 of the 
Internal Revenue Code is the amount of taxes imposed pursuant to the 
provisions of section 871 which is properly

[[Page 182]]

allocable to the undistributed portion of the distributable net income. 
See Sec. 1.665(d)-1. The amount of taxes imposed pursuant to the 
provisions of section 871 is the difference between the total tax 
imposed pursuant to the provisions of that section on the foreign trust 
created by a U.S. person for the year and the amount which would have 
been imposed on such trust had all the distributable net income, as 
determined under section 643(a), been distributed. The application of 
the rule in this paragraph may be illustrated by the following examples:

    Example 1. A trust was created in 1952 under the laws of Country X 
by the transfer to a trustee in Country X of money or property by a U.S. 
person. The entire trust constitutes a foreign trust created by a U.S. 
person. The governing instrument of the trust provides that $7,000 of 
income is required to be distributed currently to a U.S. beneficiary and 
gives the trustee discretion to make additional distributions to the 
beneficiary. During the taxable year 1963 the trust had income of 
$10,000 from dividends of a U.S. corporation (on which Federal income 
taxes of $3,000 were imposed pursuant to the provisions of section 871 
and withheld under section 1441 resulting in the receipt by the trust of 
cash in the amount of $7,000), $20,000 in capital gains from the sale of 
stock of a Country Y corporation, and $30,000 from dividends of a 
Country X corporation, none of the gross income of which was derived 
from sources within the United States. The trustee did not file a U.S. 
income tax return for the taxable year 1963. The distributable net 
income of the trust before distributions to the beneficiary for 1963 is 
$60,000 ($57,000 of which is cash). During 1963 the trustee made 
distributions to the U.S. beneficiary equaling one-half of the trust's 
distributable net income or $30,000. Thus, the U.S. beneficiary is 
treated as having had distributed to him $5,000 (composed of $3,500 as a 
cash distribution and $1,500 as the tax imposed pursuant to the 
provisions of section 871 and withheld under section 1441), representing 
one-half of the income from U.S. sources; $10,000 in cash, representing 
one-half of the capital gains from the sale of stock of the Country Y 
corporation; and $15,000 in cash, representing one-half of the income 
from Country X sources for a total of $30,000. The undistributed net 
income of the trust at the close of taxable year 1963 is $28,500 
computed as follows:

Distributable net income.....................................    $60,000
Less:                                                                   
  (1) Amounts distributed to the beneficiary--....                      
  Income currently distributed to the beneficiary.     $7,000           
  Other amounts distributed to the beneficiary....     21,500           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary....................................      1,500           
                                                   -----------          
    Total amounts distributed to the beneficiary..     30,000           
  (2) Amount of taxes imposed on the trust under                        
   chapter 1 of the Code (See Sec.  1.665(d)-1)...      1,500           
                                                   -----------          
    Total....................................................     31,500
                                                   ------------         
    Undistributed net income.................................     28,500
                                                                        

    Example 2. The facts are the same as in example 1 except that 
property has been transferred to the trust by a person other than a U.S. 
person, and during 1963 the foreign trust created by a U.S. person was 
60 percent of the entire foreign trust. The trustee paid no income taxes 
to Country X in 1963.
    (1) The undistributed net income of the foreign trust created by a 
U.S. person for 1963 is $17,100, computed as follows:

Distributable net income (60% of each item of gross income of           
 entire trust):                                                         
  60% of $10,000 U.S. dividends..............................     $6,000
  60% of $20,000 Country X capital gains.....................     12,000
  60% of $30,000 Country X dividends.........................     18,000
                                                   ------------         
    Total....................................................     36,000
Less:                                                                   
  (i) Amounts distributed to the beneficiary--                          
  Income currently distributed to the beneficiary                       
   (60% of $7,000)................................     $4,200           
  Other amounts distributed to the beneficiary                          
   (60% of $21,500)...............................     12,900           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary (60% of $1,500)....................        900           
                                                   -----------          
    Total amounts distributed to the beneficiary..     18,000           
  (ii) Amount of taxes imposed on the trust under                       
   chapter 1 of the Code (See Sec.  1.665(d)-1)                         
   (60% of $1,500)................................       $900           
                                                              ----------
    Total....................................................    $18,900
                                                   ------------         
    Undistributed net income.................................     17,100
                                                                        

    (2) The undistributed net income of the portion of the entire trust 
which is not a foreign trust created by a U.S. person for 1963 is 
$11,400, computed as follows:

Distributed net income (40% of each item of gross income of             
 entire trust)                                                          
  40% of $10,000 U.S. dividends..............................     $4,000
  40% of $20,000 Country X capital gains.....................      8,000
  40% of Country X dividends.................................     12,000
                                                   ------------         
    Total....................................................     24,000

[[Page 183]]

                                                                        
Less:                                                                   
  (i) Amounts distributed to the beneficiary--                          
  Income currently distributed to the beneficiary                       
   (40% of $7,000)................................     $2,800           
  Other amounts distributed to the beneficiary                          
   (40% of $21,500)...............................      8,600           
  Taxes under sec. 871 deemed distributed to the                        
   beneficiary (40% of $1,500)....................        600           
                                                   -----------          
    Total amounts distributed to the beneficiary..     12,000           
  (ii) Amount of taxes imposed on the trust under                       
   chapter 1 of the Code (See Sec.  1.665(d)-1)                         
   (40% of $1,500)................................       $600           
                                                   -----------          
    Total....................................................    $12,600
                                                   ------------         
    Undistributed net income.................................     11,400
                                                                        

    (c) However, the undistributed net income for any year to which an 
accumulation distribution for a later year may be thrown back may be 
reduced by accumulation distributions in intervening years and also by 
any taxes imposed on the trust which are deemed to be distributed under 
section 666 by reason of the accumulation distributions. On the other 
hand, undistributed net income for any year will not be reduced by any 
distributions in an intervening year which are excluded from the 
definition of an accumulation distribution under section 665(b), or 
which are excluded under section 663(a)(1), relating to gifts, bequests, 
etc. See paragraph (f)(5) of Sec. 1.668(b)-2 for an illustration of the 
reduction of undistributed net income for any year by a subsequent 
accumulation distribution.

[T.D. 6989, 34 FR 733, 741, Jan. 17, 1969]



Sec. 1.665(b)-1  Accumulation distributions of trusts other than certain foreign trusts; in general.

    (a) Subject to the limitations set forth in Sec. 1.665(b)-2, in the 
case of a trust other than a foreign trust created by a U.S. person, the 
term accumulation distribution for any taxable year means an amount (if 
in excess of $2,000), by which the amounts properly paid, credited, or 
required to be distributed within the meaning of section 661(a)(2) for 
that year exceed the distributable net income (determined under section 
643(a)) of the trust, reduced (but not below zero) by the amount of 
income required to be distributed currently. (In computing the amount of 
an accumulation distribution pursuant to the preceding sentence, there 
is taken into account amounts applied or distributed for the support of 
a dependent under the circumstances specified in section 677(b) or 
section 678(c) out of corpus or out of other than income for the taxable 
year and amounts used to discharge or satisfy any person's legal 
obligation as that term is used in Sec. 1.662(a)-4.) If the distribution 
as so computed is $2,000 or less, it is not an accumulation distribution 
within the meaning of subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code. If the distribution exceeds $2,000, 
then the full amount is an accumulation distribution for the purposes of 
subpart D.
    (b) Although amounts properly paid, credited, or required to be 
distributed under section 661(a)(2) do not exceed the income of the 
trust during the taxable year, an accumulation distribution may result 
if such amounts exceed distributable net income reduced (but not below 
zero) by the amount required to be distributed currently. This may 
result from the fact that expenses allocable to corpus are taken into 
account in determining taxable income and hence distributable net 
income. However, in the case of a trust other than a foreign trust 
created by a U.S. person, the provisions of subpart D will not apply 
unless there is undistributed net income in at least one of the five 
preceding taxable years. See section 666 and the regulations thereunder.
    (c) The provisions of paragraphs (a) and (b) of this section may be 
illustrated by the following examples (it is assumed in each case that 
the exclusions provided in Sec. 1.665(b)-2 do not apply):

    Example 1. A trustee properly makes a distribution to a beneficiary 
of $20,000 during the taxable year 1956, of which $10,000 is income 
required to be distributed currently to the beneficiary. The 
distributable net income of the trust is $15,000. There is an 
accumulation distribution of $5,000 computed as follows:

Total distribution...........................................    $20,000
Less: Income required to be distributed currently (section              
 661(a)(1))..................................................     10,000
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............     10,000
Distributable net income..........................    $15,000           

[[Page 184]]

                                                                        
Less: Income required to be distributed currently.     10,000           
                                                   -----------          
Balance of distributable net income..........................      5,000
                                                   ------------         
    Accumulation distribution................................      5,000
                                                                        

    Example 2. Under the terms of the trust instrument, an annuity of 
$15,000 is required to be paid to A out of income each year and the 
trustee may in his discretion make distributions out of income or corpus 
to B. During the taxable year the trust had income of $18,000, as 
defined in section 643(b), and expenses allocable to corpus of $5,000. 
Distributable net income amounted to $13,000. The trustee distributed 
$15,000 of income to A and in the exercise of his discretion, paid 
$5,000 to B. There is an accumulation distribution of $5,000 computed as 
follows:

Total distribution...........................................    $20,000
Less: Income required to be distributed currently to A                  
 (section 661(a)(1)).........................................     15,000
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............     5,000 
Distributable net income..........................    $13,000           
Less: Income required to be distributed currently                       
 to A.............................................     15,000           
                                                   -----------          
Balance of distributable net income..........................          0
                                                   ------------         
    Accumulation distribution to B...........................      5,000
                                                                        

    Example 3. Under the terms of a trust instrument, the trustee may 
either accumulate the trust income or make distributions to A and B. The 
trustee may also invade corpus for the benefit of A and B. During the 
taxable year, the trust had income as defined in section 643(b) of 
$22,000 and expenses of $5,000 allocable to corpus. Distributable net 
income amounts to $17,000. The trustee distributed $10,000 each to A and 
B during the taxable year. There is an accumulation distribution of 
$3,000 computed as follows:

Total distribution...........................................    $20,000
Less: income required to be distributed currently............          0
                                                   ------------         
    Other amounts distributed (section 661(a)(2))............     20,000
Distributable net income.....................................     17,000
                                                   ------------         
    Accumulation distribution................................      3,000
                                                                        

    (d) There are not taken into account, in computing the accumulation 
distribution for any taxable year, any amounts deemed distributed in 
that year because of an accumulation distribution in a later year.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
734, Jan. 17, 1969]



Sec. 1.665(b)-2   Exclusions from accumulation distributions in the case of trusts (other than a foreign trust created by a U.S. person).

    (a) In the case of a trust other than a foreign trust created by a 
U.S. person, certain amounts paid, credited, or required to be 
distributed to a beneficiary are excluded under section 665(b) in 
determining whether there is an accumulation distribution for the 
purposes of subpart D (section 665 and following), part I, subchapter J, 
chapter 1 of the Code. These exclusions are solely for the purpose of 
determining the amount allocable to preceding years under section 666 
and in no way affect the determination under subpart C (section 661 and 
following) of such part I of the beneficiary's tax liability for the 
year of distribution. Further, amounts excluded from accumulation 
distributions do not reduce the amount of undistributed net income for 
the 5 years preceding the year of distribution.
    (b) The amounts excluded from the computation of an accumulation 
distribution are discussed in the following subparagraphs:
    (1) Distributions from accumulations while a beneficiary is under 
21. (i) The first exception to the definition of an accumulation 
distribution is for amounts paid, credited, or required to be 
distributed to a beneficiary who was under 21 years of age or unborn 
when it was accumulated. A distribution is to be considered as so paid, 
credited, or required to be distributed to the extent, and only to the 
extent, that there is no undistributed net income for taxable years 
preceding the year of distribution other than undistributed net income 
accumulated while the beneficiary was under 21. If a distribution can be 
made from income accumulated either before or after a beneficiary 
reaches 21, it will be considered as made from the most recently 
accumulated income, and it will be so considered even though the 
governing instrument directs that distributions be charged first against 
the earliest accumulations.
    (ii) As was indicated in paragraph (a) of this section, a 
distribution of an

[[Page 185]]

amount excepted from the definition of an accumulation distribution will 
not reduce undistributed net income for the purpose of determining the 
effect of a future accumulation distribution. Thus, a distribution to a 
beneficiary of income accumulated before he reached 21 would not reduce 
the undistributed net income includible in a future accumulation 
distribution to another beneficiary. However, all future distributions 
to the same beneficiary, or to another beneficiary to whom a 
distribution would be excepted under the provisions of this 
subparagraph, would be excepted from the definition of an accumulation 
distribution to the extent that they could not be paid, credited, or 
required to be distributed from other accumulated income.
    (iii) The following examples illustrate the application of the 
foregoing rules of this subparagraph (in each of these examples it is 
assumed that the exceptions in section 665(b) (2), (3), and (4) do not 
apply):
    (a) Income is to be accumulated until A reaches 21 when the corpus 
and accumulated income are to be distributed to him. The distribution is 
not an accumulation distribution.
    (b) Income is to be accumulated until A is 21, when it is to be 
distributed to him but the corpus is to remain in trust. A distribution 
of the accumulated income to A when he reaches 21 is not an accumulation 
distribution.
    (c) Income is to be accumulated and added to corpus until A reaches 
21, when he is to receive one-third of the corpus (including 
accumulations). Thereafter all the income is to be paid to A until he is 
23 when the remaining corpus (including accumulations) is to be paid to 
him. If A dies under that age any undistributed portion is to be paid to 
B. Distributions to A at 21 and 23 out of accumulations are not 
accumulation distributions even though they include accumulated income. 
However, if A died at the age of 22, when B was 23, a distribution to B 
would be an accumulation distribution to the extent of income 
accumulations since B reached 21, and the amount of undistributed net 
income includible in the distribution will not be reduced by the 
previous distribution to A.
    (d) Income is to be accumulated and added to corpus until A is 21. 
After he is 21, he is entitled to all the income and, in addition, to 
distributions of corpus in the discretion of the trustee. When he 
reaches 25 he is entitled to the corpus. Distributions to A are not 
accumulation distributions, whether they are discretionary or upon 
termination of the trust.
    (e) The facts are the same as in the preceding example, except that 
income is to be accumulated until A is 23. Distributions to A are 
accumulation distributions to the extent of income accumulated after A 
reached 21.
    (f) Income may be distributed among a testator's children or 
accumulated and added to corpus until the youngest child is 21, when the 
corpus is to be distributed to the testator's then living descendants. 
Upon termination of the trust, the corpus is distributed to A, age 21; 
B, age 23; and C, the child of a deceased child, age 3. The 
distributions to A and C are not accumulation distributions. The 
distribution to B is an accumulation distribution to the extent of 
income accumulated after he reaches 21. (If the terms of the trust were 
such that it was subject to the separate share treatment under section 
663(c), the distribution to B would be an accumulation distribution only 
to the extent of income accumulated for B's separate share since he 
reached 21.)
    (g) Income may be distributed to A or accumulated and added to 
corpus during A's life. Upon the death of A the corpus is to be 
distributed to B. B is 23 at A's death. The distribution is an 
accumulation distribution to the extent of income accumulated since B 
reached 21.
    (2) Emergency distributions. The second exclusion from the 
definition of an accumulation distribution is for amounts properly paid 
or credited to a beneficiary to meet his emergency needs. Whether or not 
a distribution falls within this exclusion depends upon the facts and 
circumstances causing the distribution. A distribution based upon an 
unforeseen or unforeseeable combination of circumstances requiring 
immediate help to the beneficiary would qualify for the exclusion. 
However, the beneficiary must be in actual need of the distribution and 
the

[[Page 186]]

fact that he had other sufficient resources would tend to negate the 
conclusion that a distribution was to meet his emergency needs. Ordinary 
distributions for the support, maintenance, or education of the 
beneficiary would not qualify for the exclusion.
    (3) Certain distributions at specified ages. The third exclusion 
from the definition of an accumulation distribution is for amounts 
properly paid or credited to a beneficiary upon the beneficiary's 
attaining a specified age or ages; provided, (i) the total number of 
such distributions with respect to that beneficiary cannot exceed 4; 
(ii) the period between each such distribution is 4 years or more; and 
(iii) on January 1, 1954, such distributions were required by the 
specific terms of the governing instrument. Any discretionary invasion 
of corpus at other times is not excluded under this subparagraph, but 
does not affect the status of distributions that would otherwise be 
excluded. If more than four distributions are required to be made to a 
particular beneficiary at specified ages if he survives to receive them, 
none of the distributions will be excluded, even though the beneficiary 
dies before he receives more than four. On the other hand, a direction 
to make additional distributions to a remainderman will not affect the 
status of distributions required to be made to the primary beneficiary. 
For example, a trust agreement provided on January 1, 1954, that when A 
reached age 25 he would receive one-eighth of the corpus and accumulated 
income, as then constituted, and similar distributions at ages 30, 35, 
and 40. It also provided for similar distributions to B after A's death, 
and for additional discretionary distributions to both A and B. Required 
distributions to both A and B are excluded, regardless of whether 
discretionary distributions are made, but discretionary distributions 
are not excluded. On the other hand, if an additional distribution to A 
was directed when he reached 45, no distributions to him would be 
excluded, regardless of when he died.
    (4) Certain final distributions. (i) The last exception to the 
definition of an accumulation distribution is for amounts properly paid 
or credited to a beneficiary as a final distribution of a trust if the 
final distribution is made more than 9 years after the date of the last 
transfer to such trust.
    (ii) The term last transfer to such trust includes only transfers, 
whether by the original grantor or by a third person, made with a 
donative intent. A transfer arising out of a property right held by the 
trust is excluded, such as a transfer by a debtor in satisfaction of his 
indebtedness, or a distribution in liquidation or reorganization of a 
corporation. If the terms of two or more trusts include cross-remainders 
on the deaths of life beneficiaries, the donative transfers occurred at 
the time the trusts were created. The addition of the corpus of one 
trust to that of another when a remainder falls in is therefore not a 
new transfer within the meaning of section 665(b)(4).
    (iii) For example, under the terms of a trust created July 1, 1950, 
with an original corpus of $100,000, by H for the benefit of his wife, 
W, the income of the trust is to be accumulated and added to corpus. 
Upon the expiration of a 10-year period, the trust is to terminate and 
its assets, including all accumulated income, are to be distributed to 
W. No transfers were made by H or other persons to the trust after it 
was created. Both the trust and W file returns on the calendar year 
basis. In accordance with its terms, the trust terminated on June 30, 
1960, and on August 1, 1960, the trustee made a final distribution of 
the assets of the trust to W, consisting of investments derived from 
$100,000 of donated principal, accumulated income of $30,000 
attributable to the period July 1, 1950, through December 31, 1959, and 
income of $3,000 attributable to the period the trust was in existence 
during 1960. Subpart D is inapplicable to the $3,000 of income of the 
trust for 1960 since that amount would be deductible by the trust and 
includible in W's gross income for that year to the extent provided in 
subpart C. However, the balance of the distribution will qualify as an 
exclusion from the provisions of subpart D.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
735, Jan. 17, 1969]

[[Page 187]]



Sec. 1.665(b)-3   Exclusions under section 663(a)(1).

    Subpart D (section 665 and following), part I, subchapter J, chapter 
1 of the Code, has no application to an amount which qualifies as an 
exclusion under section 663(a)(1), relating to gifts, bequests, etc.



Sec. 1.665(c)-1   Accumulation distributions of certain foreign trusts; in general.

    (a) In the case of a foreign trust created by a U.S. person, the 
term accumulation distribution for any taxable year means an amount by 
which the amounts properly paid, credited, or required to be distributed 
within the meaning of section 661(a)(2) for that year exceed the 
distributable net income (determined under section 643(a)) of the trust, 
reduced (but not below zero) by the amount of income required to be 
distributed currently. (In computing the amount of an accumulation 
distribution pursuant to the preceding sentence, there is taken into 
account amounts applied or distributed for the support of a dependent 
under circumstances specified in section 677(b) and section 678(c) out 
of corpus or out of other than income for the taxable year and amounts 
used to discharge or satisfy any person's legal obligation as that term 
is used in Sec. 1.662(a)-4.)
    (b) Although amounts properly paid, credited, or required to be 
distributed under section 661(a)(2) do not exceed the income of the 
trust during the taxable year, an accumulation distribution may result 
if such amounts exceed distributable net income reduced (but not below 
zero) by the amount required to be distributed currently. This may 
result from the fact that expenses allocable to corpus are taken into 
account in determining taxable income and hence distributable net 
income. However, the provisions of subpart D will not apply unless there 
is undistributed net income in at least one of the preceding taxable 
years which began after December 31, 1953, and ended after August 16, 
1954. See section 666 and the regulations thereunder.
    (c) The provisions of paragraphs (a) and (b) of this section may be 
illustrated by the examples provided in paragraph (c) of Sec. 1.665(b)-
1.

[T.D. 6989, 34 FR 735, Jan. 17, 1969]



Sec. 1.665(c)-2  Indirect payments to the beneficiary.

    (a) In general. Except as provided in paragraph (b) of this section, 
for purposes of section 665 any amount paid to a U.S. person which is 
from a payor who is not a U.S. person and which is derived directly or 
indirectly from a foreign trust created by a U.S. person shall be deemed 
in the year of payment to the U.S. person to have been directly paid to 
the U.S. person by the trust. For example, if a nonresident alien 
receives a distribution from a foreign trust created by a U.S. person 
and then pays the amount of the distribution over to a U.S. person, the 
payment of such amount to the U.S. person represents an accumulation 
distribution to the U.S. person from the trust to the extent that the 
amount received would have been an accumulation distribution had the 
trust paid the amount directly to the U.S. person in the year in which 
the payment was received by the U.S. person. This section also applies 
in a case where a nonresident alien receives indirectly an accumulation 
distribution from a foreign trust created by a U.S. person and then pays 
it over to a U.S. person. An example of such a transaction is one where 
the foreign trust created by a U.S. person makes the distribution to an 
intervening foreign trust created by either a U.S. person or a person 
other than a U.S. person and the intervening trust distributes the 
amount received to a nonresident alien who in turn pays it over to a 
U.S. person. Under these circumstances, it is deemed that the payment 
received by the U.S. person was received directly from a foreign trust 
created by a U.S. person.
    (b) Limitation. In the case of a distribution to a beneficiary who 
is a U.S. person, paragraph (a) of this section does not apply if the 
distribution is received by such beneficiary under circumstances 
indicating lack of intent on the part of the parties to circumvent the 
purposes for which section

[[Page 188]]

7 of the Revenue Act of 1962 (76 Stat. 985) was enacted.

[T.D. 6989, 34 FR 735, Jan. 17, 1969]



Sec. 1.665(d)-1  Taxes imposed on the trust.

    (a) For the purpose of subpart D (section 665 and following), part 
I, subchapter J, chapter 1 of the Code, the term taxes imposed on the 
trust means (for any taxable year) the amount of Federal income taxes 
which are properly allocable to the undistributed portion of the 
distributable net income. This amount is the difference between the 
total taxes of the trust for the year and the amount which would have 
been paid by the trust had all of the distributable net income, as 
determined under section 643(a), been distributed. Thus, in determining 
the amount of taxes imposed on the trust for the purposes of subpart D, 
there is excluded the portion of the taxes paid by the trust which is 
attributable to items of gross income which are not includible in 
distributable net income, such as capital gains allocable to corpus. The 
rule stated in this paragraph may be illustrated by the following 
example:

    Example. (1) Under the terms of a trust which reports on the 
calendar year basis the income may be accumulated or distributed to A in 
the discretion of the trustee and capital gains are allocable to corpus. 
During the taxable year 1954, the trust had income of $20,000 from 
royalties, long-term capital gains of $10,000, and expenses of $2,000. 
The trustee in his discretion made a distribution of $10,000 to A. The 
taxes imposed on the trust for the purposes of this subpart are $2,713, 
determined as shown below.
    (2) The distributable net income of the trust computed under section 
643(a) is $18,000 (royalties of $20,000 less expenses of $2,000). The 
total taxes paid by the trust are $3,787, computed as follows:

Royalties....................................................    $20,000
Capital gains................................................     10,000
                                                   ------------         
    Gross income.............................................     30,000
Deductions:                                                             
  Expenses........................................     $2,000           
  Distributions to A..............................     10,000           
  Capital gain deduction..........................      5,000           
  Personal exemption..............................        100           
                                                   -----------          
                                                                  17,100
                                                   ------------         
    Taxable income...........................................     12,900
Total income taxes...........................................      3,787
                                                                        

    (3) The amount of taxes which would have been paid by the trust, had 
all of the distributable net income ($18,000) of the trust been 
distributed to A, is $1,074, computed as follows:

Taxable income of the trust..................................    $12,900
Less: Undistributed portion of distributable net income                 
 ($18,000-$10,000)...........................................      8,000
                                                   ------------         
    Balance of taxable income................................      4,900
Income taxes on $4,900.......................................      1,074
                                                                        

    (4) The amount of taxes imposed on the trust as defined in this 
paragraph is $2,713, computed as follows:

Total taxes.......................................     $3,787           
  Taxes which would have been paid by the trust                         
   had all of the distributable net income been                         
   distributed....................................      1,074           
                                                   ------------         
  Taxes imposed on the trust as defined in this                         
   paragraph......................................      2,713           
                                                                        

    (b) If in any subsequent year an accumulation distribution is made 
by the trust which results in a throwback to the taxable year, the taxes 
of the taxable year allocable to the undistributed portion of 
distributable net income (the taxes imposed on the trust), after the 
close of the subsequent year, are the taxes prescribed in paragraph (a) 
of this section reduced by the taxes of the taxable year allowed as 
credits to beneficiaries on account of amounts deemed distributed on the 
last day of the taxable year under section 666. See paragraph (f)(4) of 
Sec. 1.668(b)-2 for an illustration of the application of this 
paragraph.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960. Redesignated by T.D. 6989, 34 FR 
735, Jan. 17, 1969]



Sec. 1.665(e)-1   Preceding taxable year.

    (a) Definition. For purposes of subpart D (section 665 and 
following), part I, subchapter J, chapter 1 of the Internal Revenue Code 
of 1954, the term preceding taxable year does not include any taxable 
year to which such part I does not apply. See section 683 and 
regulations thereunder. Accordingly, the provisions of such subpart D 
may not, in general, be applied to any taxable year which begins before 
1954 or ends before August 17, 1954. For example, if a trust (reporting 
on the calendar year basis) makes a distribution during the calendar 
year 1955 of income accumulated during prior years and the distribution 
exceeds the distributable net income of

[[Page 189]]

1955, the excess distribution may be allocated under such subpart D to 
1954, but it may not be allocated to 1953 and preceding years, since the 
Internal Revenue Code of 1939 applies to those years.
    (b) Simple trusts subject to subpart D. An accumulation distribution 
may be properly allocated to a preceding taxable year in which the trust 
qualified as a simple trust (that is, qualified for treatment under 
subpart B (section 651 and following) of such part I). In such event, 
the trust is treated for such preceding taxable year in all respects as 
if it were a trust to which subpart C (section 661 and following) of 
such part I applies. An example of such a circumstance would be in the 
case of a trust (required under the trust instrument to distribute all 
of its income currently) which received in the preceding taxable year 
extraordinary dividends or taxable stock dividends which the trustee in 
good faith allocated to corpus, but which are subsequently determined to 
be currently distributable to the beneficiary. See section 643(a)(4) and 
Sec. 1.643(a)-4. The trust would qualify for treatment under such 
subpart C for the year of distribution of the extraordinary dividends or 
taxable stock dividends, because the distribution is not out of income 
of the current taxable year and would be treated as other amounts 
properly paid or credited or required to be distributed for such taxable 
year within the meaning of section 661(a)(2). Also, in the case of a 
trust other than a foreign trust created by a U.S. person, the 
distribution would qualify as an accumulation distribution for the 
purposes of such subpart D if in excess of $2,000 and not excepted under 
section 665(b) and the regulations thereunder. In the case of a foreign 
trust created by a U.S. person, the distribution, regardless of the 
amount, would qualify as an accumulation distribution for the purposes 
of subpart D. For the purposes only of such subpart D, the trust would 
be treated as subject to the provisions of such subpart C for the 
preceding taxable year in which the extraordinary or taxable stock 
dividends were received and in computing undistributed net income for 
such preceding year, the extraordinary or taxable stock dividends would 
be included in distributable net income under section 643(a). The rule 
stated in the preceding sentence would also apply if the distribution in 
the later year were made out of corpus without regard to a determination 
that the extraordinary dividends or taxable stock dividends in question 
were currently distributable to the beneficiary.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
735, Jan. 17, 1969. Redesignated by T.D. 6989, 34 FR 735, Jan. 17, 1969]



Sec. 1.665(e)-2  Application of separate share rule.

    In trusts to which the separate share rule of section 663(c) is 
applicable for any taxable year, subpart D (section 665 and following), 
part I, subchapter J, of the Code, is applied as if each share were a 
separate trust. Thus, ``undistributed net income'' and the amount of an 
``accumulation distribution'' are computed separately for each share. 
The ``taxes imposed on the trust'' are allocated as follows:
    (a) There is first allocated to each separate share that portion of 
the ``taxes imposed on the trust'', computed before the allowance of 
credits under section 642(a), which bears the same relation to the total 
that the distributable net income of the separate share bears to the 
distributable net income of the trust, adjusted for this purpose as 
follows:
    (1) There is excluded from distributable net income of the trust and 
of each separate share any tax-exempt interest, foreign income of a 
foreign trust, and excluded dividends, to the extent such amounts are 
included in distributable net income pursuant to section 643(a) (5), 
(6), and (7); and
    (2) The distributable net income of the trust is reduced by any 
deductions allowable under section 661 for amounts paid, credited, or 
required to be distributed during the taxable year, and the 
distributable net income of each separate share is reduced by any such 
deduction allocable to that share.
    (b) The taxes so determined for each separate share are then reduced 
by that portion of the credits against tax allowable to the trust under 
section 642(a) in computing the ``taxes imposed

[[Page 190]]

on the trust'' which bear the same relation to the total that the items 
of income allocable to the separate share with respect to which the 
credit is allowed bear to the total of such items of the trust. The 
amount of taxes imposed on the trust allocable to a separate share as so 
determined is then reduced by the amount of the taxes allowed under 
sections 667 and 668 as a credit to a beneficiary of the separate share 
on account of any accumulation distribution determined for any taxable 
year intervening between the year for which the determination is made 
and the year of an accumulation distribution with respect to which the 
determination is made. See paragraph (b) of Sec. 1.665(d)-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
741, Jan. 17, 1969. Redesignated by T.D. 6989, 34 FR 736, Jan. 17, 1969]



Sec. 1.666(a)-1A   Amount allocated.

    (a) In general. In the case of a trust that is subject to subpart C 
of part I of subchapter J of chapter 1 of the Code (relating to estates 
and trusts that may accumulate income or that distribute corpus), 
section 666(a) prescribes rules for determining the taxable years from 
which an accumulation distribution will be deemed to have been made and 
the extent to which the accumulation distribution is considered to 
consist of undistributed net income. In general, an accumulation 
distribution made in taxable years beginning after December 31, 1969, is 
deemed to have been made first from the earliest preceding taxable year 
of the trust for which there is undistributed net income. An 
accumulation distribution made in a taxable year beginning before 
January 1, 1970, is deemed to have been made first from the most recent 
preceding taxable year of the trust for which there is undistributed net 
income. See Sec. 1.665(e)-1A for the definition of ``preceding taxable 
year.''
    (b) Distributions by domestic trusts--(1) Taxable years beginning 
after December 31, 1973. An accumulation distribution made by a trust 
(other than a foreign trust created by a U.S. person) in any taxable 
year beginning after December 31, 1973, is allocated to the preceding 
taxable years of the trust (defined in Sec. 1.665(e)-1A(a)(1)(ii) as 
those beginning after December 31, 1968) according to the amount of 
undistributed net income of the trust for such years. For this purpose, 
an accumulation distribution is first to be allocated to the earliest 
such preceding taxable year in which there is undistributed net income 
and shall then be allocated, beginning with the next earliest, to any 
remaining preceding taxable years of the trust. The portion of the 
accumulation distribution allocated to the earliest preceding taxable 
year is the amount of the undistributed net income for that preceding 
taxable year. The portion of the accumulation distribution allocated to 
any preceding taxable year subsequent to the earliest such preceding 
taxable year is the excess of the accumulation distribution over the 
aggregate of the undistributed net income for all earlier preceding 
taxable years. See paragraph (d) of this section for adjustments to 
undistributed net income for prior distributions. The provisions of this 
subparagraph may be illustrated by the following example:

    Example. In 1977, a domestic trust reporting on the calendar year 
basis makes an accumulation distribution of $33,000. Therefore, years 
before 1969 are ignored. In 1969, the trust had $6,000 of undistributed 
net income; in 1970, $4,000; in 1971, none; in 1972, $7,000; in 1973, 
$5,000; in 1974, $8,000; in 1975, $6,000; and $4,000 in 1976. The 
accumulation distribution is deemed distributed $6,000 in 1969, $4,000 
in 1970, none in 1971, $7,000 in 1972, $5,000 in 1973, $8,000 in 1974, 
and $3,000 in 1975.

    (2) Taxable years beginning after December 31, 1969, and before 
January 1, 1974. If a trust (other than a foreign trust created by a 
U.S. person) makes an accumulation distribution in a taxable year 
beginning after December 31, 1969, and before January 1, 1974, the 
distribution will be deemed distributed in the same manner as 
accumulation distributions qualifying under subparagraph (1) of this 
paragraph, except that the first year to which the distribution may be 
thrown back cannot be earlier than the fifth taxable year of the trust 
preceding the year in which the accumulation distribution is made. Thus, 
for example, in the case of an accumulation distribution made in the 
taxable year of a domestic trust which begins on January 1, 1972, the 
taxable year of

[[Page 191]]

the trust beginning on January 1, 1967, would be the first year in which 
the distribution was deemed made, assuming that there was undistributed 
net income for 1967. See also Sec. 1.665(e)-1A(a)(1). The provisions of 
this subparagraph may be illustrated by the following example:

    Example. In 1973, a domestic trust, reporting on the calendar year 
basis, makes an accumulation distribution of $25,000. In 1968, the fifth 
year preceding 1973, the trust had $7,000 of undistributed net income; 
in 1969, none; in 1970, $12,000; in 1971, $4,000; in 1972, $4,000. The 
accumulation distribution is deemed distributed in the amounts of $7,000 
in 1968, none in 1969, $12,000 in 1970, $4,000 in 1971, and $2,000 in 
1972.

    (3) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (c) Distributions by foreign trusts-- (1) Foreign trusts created 
solely by U.S. persons--(i) Taxable years beginning after December 31, 
1969. If a foreign trust created by a U.S. person makes an accumulation 
distribution in any taxable year beginning after December 31, 1969, the 
distribution is allocated to the trust's preceding taxable years 
(defined in Sec. 1.665(e)-1A(a)(2) as those beginning after Dec. 31, 
1953, and ending after Aug. 16, 1954) according to the amount of 
undistributed net income of the trust for such years. For this purpose, 
an accumulation distribution is first allocated to the earliest such 
preceding taxable year in which there is undistributed net income and 
shall then be allocated in turn, beginning with the next earliest, to 
any remaining preceding taxable years of the trust. The portion of the 
accumulation distribution allocated to the earliest preceding taxable 
year is the amount of the undistributed net income for that preceding 
taxable year. The portion of the accumulation distribution allocated to 
any preceding taxable year subsequent to the earliest such preceding 
taxable year is the excess of the accumulation distribution over the 
aggregate of the undistributed net income for all earlier preceding 
taxable years. See paragraph (d) of this section for adjustments to 
undistributed net income for prior distributions. The provisions of this 
subdivision may be illustrated by the following example:

    Example. In 1971, a foreign trust created by a U.S. person, 
reporting on the calendar year basis, makes an accumulation distribution 
of $50,000. In 1961, the trust had $12,000 of undistributed net income; 
in 1962, none; in 1963, $10,000; in 1964, $8,000; in 1965, $5,000; in 
1966, $14,000; in 1967, none; in 1968, $3,000; in 1969, $2,000; and in 
1970, $1,000. The accumulation distribution is deemed distributed in the 
amounts of $12,000 in 1961, none in 1962, $10,000 in 1963, $8,000 in 
1964, $5,000 in 1965, $14,000 in 1966, none in 1967, and $1,000 in 1968.

    (ii) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (2) Foreign trusts created partly by U.S. persons--(i) Taxable years 
beginning after December 31, 1969. If a trust that is in part a foreign 
trust created by a U.S. person and in part a foreign trust created by a 
person other than a U.S. person makes an accumulation distribution in 
any year after December 31, 1969, the distribution is deemed made from 
the undistributed net income of the foreign trust created by a U.S. 
person in the proportion that the total undistributed net income for all 
preceding years of the foreign trust created by the U.S. person bears to 
the total undistributed net income for all years of the entire foreign 
trust. In addition, such distribution is deemed made from the 
undistributed net income of the foreign trust created by a person other 
than a U.S. person in the proportion that the total undistributed net 
income for all preceding years of the foreign trust created by a person 
other than a U.S. person bears to the total undistributed net income for 
all years of the entire foreign trust. Accordingly, an accumulation 
distribution of such a trust is composed of two portions with one 
portion relating to the undistributed net income of the foreign trust 
created by the U.S. person and the other portion relating to the 
undistributed net income of the foreign trust created by the person 
other than a U.S. person. For these purposes, each

[[Page 192]]

portion of an accumulation distribution made in any taxable year is 
first allocated to each of such preceding taxable years in turn, 
beginning with the earliest preceding taxable year, as defined in 
Sec. 1.665(e)-1A(a), of the applicable foreign trusts, to the extent of 
the undistributed net income for the such trust for each of those years. 
Thus, each portion of an accumulation distribution is deemed to have 
been made from the earliest accumulated income of the applicable trust. 
If the foreign trust created by a U.S. person makes an accumulation 
distribution in any year beginning after December 31, 1969, the 
distribution is included in the beneficiary's income for that year to 
the extent of the undistributed net income of the trust for the trust's 
preceding taxable years which began after December 31, 1953, and ended 
after August 16, 1954. The provisions of this subdivision may be 
illustrated by the following example:

    Example. A trust is created in 1962 under the laws of Country X by 
the transfer to a trustee in Country X of property by both a U.S. person 
and a person other than a U.S. person. Both the trust and the only 
beneficiary of the trust (who is a U.S. person) report their taxable 
income on a calendar year basis. On March 31, 1974, the trust makes an 
accumulation distribution of $150,000 to the beneficiary. The 
distributable net income of both the portion of the trust which is a 
foreign trust created by a U.S. person and the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
for each year is computed in accordance with the provisions of paragraph 
(b)(3) of Sec. 1.643(d)-1 and the undistributed net income for each 
portion of the trust for each year is computed as described in paragraph 
(b) of Sec. 1.665(a)-1A. For taxable years 1962 through 1973, the 
portion of the trust which is a foreign trust created by a U.S. person 
and the portion of the trust which is a foreign trust created by a 
person other than a U.S. person had the following amounts of 
undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                            Undistributed net   
                                                                    Undistributed net     income-portion of the 
                              Year                                income-portion of the     trust created by a  
                                                                    trust created by a     person other than a  
                                                                       U.S. person             U.S. person      
----------------------------------------------------------------------------------------------------------------
1962............................................................           $7,000                  $4,000       
1963............................................................           12,000                   7,000       
1964............................................................             None                    None       
1965............................................................           11,000                   5,000       
1966............................................................            8,000                   3,000       
1967............................................................             None                    None       
1968............................................................            4,000                   2,000       
1969............................................................           17,000                   8,000       
1970............................................................           16,000                   9,000       
1971............................................................             None                    None       
1972............................................................           25,000                  12,000       
1973............................................................           20,000                  10,000       
                                                                 -----------------------------------------------
  Totals........................................................          120,000                  60,000       
----------------------------------------------------------------------------------------------------------------

The accumulation distribution in the amount of $150,000 is deemed to 
have been distributed in the amount of $100,000 (120,000/
180,000 x $150,000) from the portion of the trust which is a foreign 
trust created by a U.S. person and in the amount of $39,000, which is 
less than $50,000 (60,000/180,000 x $150,000), from the portion of the 
trust which is a foreign trust created by a person other than a U.S. 
person computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                          Throwback to preceding
                                                                        Throwback to     years of portion of the
                                                                     preceding years of    entire foreign trust 
                               Year                                    foreign trust      which is not a foreign
                                                                     created by a U.S.   trust created by a U.S.
                                                                           person                 person        
----------------------------------------------------------------------------------------------------------------
1962..............................................................          $7,000                   None       
1963..............................................................          12,000                   None       
1964..............................................................            None                   None       
1965..............................................................         $11,000                   None       
1966..............................................................           8,000                   None       
1967..............................................................            None                   None       
1968..............................................................           4,000                   None       
1969..............................................................          17,000                 $8,000       
1970..............................................................          16,000                  9,000       
1971..............................................................            None                   None       
1972..............................................................         $25,000                $12,000       
1973..............................................................            None                 10,000       
                                                                   ---------------------------------------------
  Totals..........................................................         100,000                 39,000       
----------------------------------------------------------------------------------------------------------------

Pursuant to this paragraph, the accumulation distribution in the amount 
of $100,000 from the portion of the trust which is a foreign trust 
created by a U.S. person is included in the beneficiary's income for 
1974, as the amount represents undistributed net income of the trust for 
the   trust's preceding taxable years which began after December 31, 
1953, and ended after August 16, 1954. The accumulation distribution in 
the amount of $50,000 from the portion of the trust which is a foreign 
trust created by a person other than a U.S. person is included in the 
beneficiary's income for 1974 to the extent of the undistributed net 
income of the trust for the preceding years beginning after December 31, 
1968. Accordingly, with respect to the portion of the trust which is a 
foreign trust created by a person other than a U.S. person, only the 
undistributed net income for the years 1969 through 1973, which totals 
$39,000, is includible in the beneficiary's income for 1974. Thus, of 
the $150,000 distribution made in 1974, the beneficiary is required to 
include a total of $139,000 in his income for 1974. The balance of 
$11,000 is deemed to represent a distribution of corpus.


[[Page 193]]


    (ii) Taxable years beginning after December 31, 1968, and before 
January 1, 1970. Accumulation distributions made in taxable years of the 
trust beginning after December 31, 1968, and before January 1, 1970, are 
allocated to prior years according to Sec. 1.666(a)-1.
    (3) Foreign trusts created by non-U.S. persons. To the extent that a 
foreign trust is a foreign trust created by a person other than a U.S. 
person, an accumulation distribution is included in the beneficiary's 
income for the year paid, credited, or required to be distributed to the 
extent provided under paragraph (b) of this section.
    (d) Reduction of undistributed net income for prior accumulation 
distributions. For the purposes of allocating to any preceding taxable 
year an accumulation distribution of the taxable year, the undistributed 
net income of such preceding taxable year is reduced by the amount from 
such year deemed distributed in any accumulation distribution of 
undistributed net income made in any taxable year intervening between 
such preceding taxable year and the taxable year. Accordingly, for 
example, if a trust has undistributed net income for 1974 and makes 
accumulation distributions during the taxable years 1978 and 1979, in 
determining that part of the 1979 accumulation distribution that is 
thrown back to 1974 the undistributed net income for 1974 is first 
reduced by the amount of the undistributed net income for 1974 deemed 
distributed in the 1978 accumulation distribution.
    (e) Rule when no undistributed net income. If, before the 
application of the provisions of subpart D to an accumulation 
distribution for the taxable year, there is no undistributed net income 
for a preceding taxable year, then no portion of the accumulation 
distribution is undistributed net income deemed distributed on the last 
day of such preceding taxable year. Thus, if an accumulation 
distribution is made during the taxable year 1975 from a trust whose 
earliest preceding taxable year is taxable year 1970, and the trust had 
no undistributed net income for 1970, then no portion of the 1975 
accumulation distribution is undistributed net income deemed distributed 
on the last day of 1970.

[T.D. 7204, 37 FR 17143, Aug. 25, 1972]



Sec. 1.666(b)-1A   Total taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed net income for such preceding 
taxable year, then an additional amount equal to the ``taxes imposed on 
the trust attributable to the undistributed net income'' (as defined in 
Sec. 1.665(d)-1A(b)) for such preceding taxable year is also deemed 
distributed under section 661(a)(2). For example, a trust has 
undistributed net income of $8,000 for the taxable year 1974. The taxes 
imposed on the trust attributable to the undistributed net income are 
$3,032. During the taxable year 1977, an accumulation distribution of 
$8,000 is made to the beneficiary, which is deemed under Sec. 1.666(a)-
1A to have been distributed on the last day of 1974. The 1977 
accumulation distribution is not less than the 1974 undistributed net 
income. Accordingly, the taxes of $3,032 imposed on the trust 
attributable to the undistributed net income for 1974 are also deemed to 
have been distributed on the last day of 1974. Thus, a total of $11,032 
will be deemed to have been distributed on the last day of 1974.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed net income are computed after taking into account any 
accumulation distributions of taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (d) of 
Sec. 1.666(a)-1A.

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]



Sec. 1.666(c)-1A   Pro rata portion of taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such

[[Page 194]]

preceding taxable year, then an additional amount is also deemed 
distributed under section 661(a)(2). The additional amount is equal to 
the ``taxes imposed on the trust attributable to the undistributed net 
income'' (as defined in Sec. 1.665(a)-1A(b)) for such preceding taxable 
year, multiplied by a fraction, the numerator of which is the amount of 
the accumulation distribution allocated to such preceding taxable year 
and the denominator of which is the undistributed net income for such 
preceding taxable year. See paragraph (b) of example 1 and paragraphs 
(c) and (f) of example 2 in Sec. 1.666(c)-2A for illustrations of this 
paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed net income are computed after taking into account any 
accumulation distributions of any taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (d) of 
Sec. 1.666(a)-1A and paragraph (c) of example 1 and paragraphs (e) and 
(h) of example 2 in Sec. 1.666(c)-2A.

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]



Sec. 1.666(c)-2A   Illustration of the provisions of section 666 (a), (b), and (c).

    The application of the provisions of Secs. 1.666(a)-1A, 1.666(b)-1A, 
and 1.666(c)-1A may be illustrated by the following examples:

    Example 1. (a) A trust created on January 1, 1974, makes 
accumulation distributions as follows:

1979..............................................................$7,000
1980..............................................................26,000

For 1974 through 1978, the undistributed portion of distributable net 
income, taxes imposed on the trust attributable to the undistributed net 
income, and undistributed net income are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                Taxes imposed on                
                                                                Undistributed       the trust                   
                             Year                                 portion of     attributable to   Undistributed
                                                                distributable   the undistributed    net income 
                                                                  net income       net income                   
----------------------------------------------------------------------------------------------------------------
1974..........................................................     $12,100            $3,400          $8,700    
1975..........................................................      16,100             5,200          10,900    
1976..........................................................       6,100             1,360           4,740    
1977..........................................................        None              None            None    
1978..........................................................      10,100             2,640           7,460    
----------------------------------------------------------------------------------------------------------------

The trust has no undistributed capital gain.
    (b) Since the entire amount of the accumulation distribution for 
1979 ($7,000) is less than the undistributed net income for 1974 
($8,700), an additional amount of $2,736 (7,000/8,700 x $3,400) is 
deemed distributed under section 666(c).
    (c) In allocating the accumulation distribution for 1980, the amount 
of undistributed net income for 1974 will reflect the accumulation 
distribution for 1979. The undistributed net income for 1974 will then 
be $1,700 and the taxes imposed on the trust for 1974 will be $664, 
determined as follows:


Undistributed net income as of the close of 1974............      $8,700
Less: Accumulation distribution (1979)......................       7,000
                                                             -----------
    Balance (undistributed net income as of the close of                
     1979)..................................................       1,700
                                                             ===========
Taxes imposed on the trust attributable to the undistributed            
 net income as of the close of 1979 (1,700/8,700 x $3,400)..         664
                                                                        

    (d) The accumulation distribution of $26,000 for 1980 is deemed to 
have been made on the last day of the preceding taxable years of the 
trust to the extent of $24,800, the total of the undistributed net 
income for such years, as shown in the tabulation below. In addition, 
$9,864, the total taxes imposed on the trust attributable to the 
undistributed net income for such years is also deemed to have been 
distributed on the last day of such years, as shown below:

------------------------------------------------------------------------
                                Undistributed net   Taxes imposed on the
            Year                     income                 trust       
------------------------------------------------------------------------
1974........................         $1,700                  $664       
1975........................         10,900                 5,200       
1976........................          4,740                 1,360       
1977........................           None                  None       
1978........................          7,460                 2,640       
1979........................           None                  None       
------------------------------------------------------------------------


[[Page 195]]

    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The entire income of the trust is from 
royalties. Both X and the trust report on the calendar year basis. All 
of the income for 1974 was accumulated. The distributable net income of 
the trust for the taxable year 1974 is $20,100 and the income taxes paid 
by the trust for 1974 attributable to the undistributed net income are 
$7,260. All of the income for 1975 and 1976 was distributed and in 
addition the trustee made accumulation distributions within the meaning 
of section 665(b) of $5,420 for each year.
    (b) The undistributed net income of the trust determined under 
section 665(a) as of the close of 1974, is $12,840, computed as follows:

Distributable net income....................................     $20,100
Less: Taxes imposed on the trust attributable to the                    
 undistributed net income...................................       7,260
                                                             -----------
    Undistributed net income as of the close of 1974........      12,840
                                                                        

    (c) The accumulation distribution of $5,420 made during the taxable 
year 1975 is deemed under section 666(a) to have been made on December 
31, 1974. Since this accumulation distribution is less than the 1974 
undistributed net income of $12,840, a portion of the taxes imposed on 
the trust for 1974 is also deemed under section 666(c) to have been 
distributed on December 31, 1974. The total amount deemed to have been 
distributed to X on December 31, 1974 is $8,484, computed as follows:

Accumulation distribution...................................      $5,420
Taxes deemed distributed (5,420/ 12,840 x $7,260)...........       3,064
                                                             -----------
    Total...................................................       8,484
                                                                        

    (d) After the application of the provisions of subpart D to the 
accumulation distribution of 1975, the undistributed net income of the 
trust for 1974 is $7,420, computed as follows:

Undistributed net income as of the close of 1974............     $12,840
Less: 1975 accumulation distribution deemed distributed on              
 December 31, 1974 (paragraph (c) of this example)..........       5,420
                                                             -----------
    Undistributed net income for 1974 as of the close of                
     1975...................................................       7,420
                                                                        

    (e) The taxes imposed on the trust attributable to the undistributed 
net income for the taxable year 1974, as adjusted to give effect to the 
1975 accumulation distribution, amount to $4,196, computed as follows:

Taxes imposed on the trust attributable to undistributed net            
 income as of the close of 1974.............................      $7,260
Less: Taxes deemed distributed in 1974......................       3,064
                                                             -----------
    Taxes attributable to the undistributed net income                  
     determined as of the close of 1975.....................       4,196
                                                                        

    (f) The accumulation distribution of $5,420 made during the taxable 
year 1976 is, under section 666(a), deemed a distribution to X on 
December 31, 1974, within the meaning of section 661(a)(2). Since the 
accumulation distribution is less than the 1974 adjusted undistributed 
net income of $7,420, the trust is deemed under section 666(c) also to 
have distributed on December 31, 1974, a portion of the taxes imposed on 
the trust for 1974. The total amount deemed to be distributed on 
December 31, 1974, with respect to the accumulation distribution made in 
1976, is $8,484, computed as follows:

Accumulation distribution...................................      $5,420
Taxes deemed distributed (5,420/ 7,420 x $4,196)............       3,064
                                                             -----------
    Total...................................................       8,484
                                                                        

    (g) After the application of the provisions of subpart D to the 
accumulation distribution of 1976, the undistributed net income of the 
trust for 1974 is $2,000, computed as follows:

Undistributed net income for 1974 as of the close of 1975...      $7,420
Less: 1976 accumulation distribution deemed distributed on              
 December 31, 1974 (paragraph (f) of this example)..........       5,420
                                                             -----------
    Undistributed net income for 1974 as of the close of                
     1976...................................................       2,000
                                                                        

    (h) The taxes imposed on the trust attributable to the undistributed 
net income of the trust for the taxable year 1974, determined as of the 
close of the taxable year 1976, amount to $1,132 ($4,196 less $3,064).

[T.D. 7204, 37 FR 17145, Aug. 25, 1972]



Sec. 1.666(d)-1A   Information required from trusts.

    (a) Adequate records required. For all taxable years of a trust, the 
trustee must retain copies of the trust's income tax return as well as 
information pertaining to any adjustments in the tax shown as due on the 
return. The trustee shall also keep the records of the trust required to 
be retained by section 6001 and the regulations thereunder for each 
taxable year as to which

[[Page 196]]

the period of limitations on assessment of tax under section 6501 has 
not expired. If the trustee fails to produce such copies and records, 
and such failure is due to circumstances beyond the reasonable control 
of the trustee or any predecessor trustee, the trustee may reconstruct 
the amount of corpus, accumulated income, etc., from competent sources 
(including, to the extent permissible, Internal Revenue Service 
records). To the extent that an accurate reconstruction can be made for 
a taxable year, the requirements of this paragraph shall be deemed 
satisfied for such year.
    (b) Rule when information is not available--(1) Accumulation 
distributions. If adequate records (as required by paragraph (a) of this 
section) are not available to determine the proper application of 
subpart D to an accumulation distribution made in a taxable year by a 
trust, such accumulation distribution shall be deemed to consist of 
undistributed net income earned during the earliest preceding taxable 
year (as defined in Sec. 1.665(e)-1A) of the trust in which it can be 
established that the trust was in existence. If adequate records are 
available for some years, but not for others, the accumulation 
distribution shall be allocated first to the earliest preceding taxable 
year of the trust for which there are adequate records and then to each 
subsequent preceding taxable year for which there are adequate records. 
To the extent that the distribution is not allocated in such manner to 
years for which adequate records are available, it will be deemed 
distributed on the last day of the earliest preceding taxable year of 
the trust in which it is established that the trust was in existence and 
for which the trust has no records. The provisions of this subparagraph 
may be illustrated by the following example:

    Example. A trust makes a distribution in 1975 of $100,000. The 
trustee has adequate records for 1973, 1974, and 1975. The records show 
that the trust is on the calendar year basis, had distributable net 
income in 1975 of $20,000, and undistributed net income in 1974 of 
$15,000, and in 1973 of $16,000. The trustee has no other records of the 
trust except for a copy of the trust instrument showing that the trust 
was established on January 1, 1965. He establishes that the loss of the 
records was due to circumstances beyond his control. Since the 
distribution is made in 1975, the earliest ``preceding taxable year'', 
as defined in Sec. 1.665(e)-1A, is 1969. Since $80,000 of the 
distribution is an accumulation distribution, and $31,000 thereof is 
allocated to 1974 and 1973, $49,000 is deemed to have been distributed 
on the last day of 1969.

    (2) Taxes. (i) If an amount is deemed under this paragraph to be 
undistributed net income allocated to a preceding taxable year for which 
adequate records are not available, there shall be deemed to be ``taxes 
imposed on the trust'' for such preceding taxable year an amount equal 
to the taxes that the trust would have paid if the deemed undistributed 
net income were the amount remaining when the taxes were subtracted from 
taxable income of the trust for such year. For example, assume that an 
accumulation distribution in 1975 of $100,000 is deemed to be 
undistributed net income from 1971, and that the taxable income required 
to produce $100,000 after taxes in 1971 would be $284,966. Therefore the 
amount deemed to be ``taxes imposed on the trust'' for such preceding 
taxable year is $184,966.
    (ii) The credit allowed by section 667(b) shall not be allowed for 
any amount deemed under this subparagraph to be ``taxes imposed on the 
trust.''

[T.D. 7204, 37 FR 17146, Aug. 25, 1972]



Sec. 1.666(a)-1   Amount allocated.

    (a)(1) If a trust other than a foreign trust created by a U.S. 
person makes an accumulation distribution in any taxable year, the 
distribution is included in the beneficiary's gross income for that year 
to the extent of the undistributed net income of the trust for the 
preceding 5 years. It is therefore necessary to determine the extent to 
which there is undistributed net income for the preceding 5 years. For 
this purpose, an accumulation distribution made in any taxable year is 
allocated to each of the 5 preceding taxable years in turn, beginning 
with the most recent year, to the extent of the undistributed net income 
of each of those years. Thus, an accumulation distribution is deemed to 
have been made from the most recently accumulated income of the trust.

[[Page 197]]

    (2) If a foreign trust created by a U.S. person makes an 
accumulation distribution in any year after December 31, 1962, the 
distribution is included in the beneficiary's gross income for that year 
to the extent of the undistributed net income of the trust for the 
trust's preceding taxable years which began after December 31, 1953, and 
ended after August 16, 1954. It is therefore necessary to determine the 
extent to which there is undistributed net income for such preceding 
taxable years. For this purpose, an accumulation distribution made in 
any taxable year is first allocated to each of such preceding taxable 
years in turn, beginning with the most recent year, to the extent of the 
undistributed net income of each of those years. Thus, an accumulation 
distribution is deemed to have been made from the most recently 
accumulated income of the trust.
    (3) If a trust that is in part a foreign trust created by a U.S. 
person and in part a foreign trust created by a person other than a U.S. 
person makes an accumulation distribution in any year after December 31, 
1962, the distribution is deemed made from the undistributed net income 
of the foreign trust created by a U.S. person in the proportion that the 
total undistributed net income for all preceding years of the foreign 
trust created by the U.S. person bears to the total undistributed net 
income for all years of the entire foreign trust. In addition, such 
distribution is deemed made from the undistributed net income of the 
foreign trust created by a person other than a U.S. person in the 
proportion that the total undistributed net income for all preceding 
years of the foreign trust created by a person other than a U.S. person 
bears to the total undistributed net income for all years of the entire 
foreign trust. Accordingly, an accumulation distribution of such a trust 
is composed of two portions with one portion relating to the 
undistributed net income of the foreign trust created by the U.S. person 
and the other portion relating to the undistributed net income of the 
foreign trust created by the person other than a U.S. person. For these 
purposes, each portion of an accumulation distribution made in any 
taxable year is first allocated to each of such preceding taxable years 
in turn, beginning with the most recent year, to the extent of the 
undistributed net income for the applicable foreign trust for each of 
those years. Thus, each portion of an accumulation distribution is 
deemed to have been made from the most recently accumulated income of 
the applicable trust. If the foreign trust created by a U.S. person 
makes an accumulation distribution in any year after December 31, 1962, 
the distribution is included in the beneficiary's gross income for that 
year to the extent of the undistributed net income of the trust for the 
trust's preceding taxable years which began after December 31, 1953, and 
ended after August 16, 1954. If the foreign trust created by a person 
other than a U.S. person makes an accumulation distribution in any 
taxable year, the distribution is included in the beneficiary's gross 
income for that year to the extent of the undistributed net income of 
the trust for the preceding 5 years.
    (b) If, before the application of the provisions of subpart D 
(section 665 and following), part I, subchapter J, chapter 1 of the 
Code, to an accumulation distribution for the taxable year, there is no 
undistributed net income for a preceding taxable year, then no portion 
of the accumulation distribution is deemed distributed on the last day 
of such preceding taxable year. Thus, if an accumulation distribution is 
made during the taxable year 1960 and the trust had no undistributed net 
income for the taxable year 1959, then no portion of the 1960 
accumulation distribution is deemed distributed on the last day of 1959. 
For purposes of subpart D, the term 5 preceding taxable years includes 
only the 5 taxable years immediately preceding the taxable year in which 
the accumulation distribution is made and which are subject to part I 
(section 641 and following) of such subchapter J even though the trust 
has no undistributed net income during one or more of those years.
    (c) Paragraphs (a) and (b) of this section may be illustrated by the 
following examples:

    Example 1. In 1964, a domestic trust, reporting on the calendar year 
basis, makes an accumulation distribution of $25,000. In 1963,

[[Page 198]]

the trust had $7,000 of undistributed net income; in 1962, none; in 
1961, $12,000; in 1960, $4,000; in 1959, $4,000. The accumulation 
distribution is deemed distributed $7,000 in 1963, none in 1962, $12,000 
in 1961, $4,000 in 1960, and $2,000 in 1959.
    Example 2. In 1964, a foreign trust created by a U.S. person, 
reporting on the calendar year basis, makes an accumulation distribution 
of $50,000. In 1963, the trust had $12,000 of undistributed net income; 
in 1962, none; in 1961, $10,000; in 1960, $8,000; in 1959, $5,000; in 
1958, $14,000; in 1957, none; in 1956, $3,000; in 1955, $2,000; and in 
1954, $1,000. The accumulation distribution is deemed distributed 
$12,000 in 1963, none in 1962, $10,000 in 1961, $8,000 in 1960, $5,000 
in 1959, $14,000 in 1958, none in 1957, $1,000 in 1956.
    Example 3. A trust is created in 1952 under the laws of Country X by 
the transfer to a trustee in Country X of money and property by both a 
U.S. person and a person other than a U.S. person. Both the trust and 
the only beneficiary of the trust (who is a U.S. person) report their 
taxable income on a calendar year basis. On March 31, 1964, the trust 
makes an accumulation distribution of $150,000 to the U.S. beneficiary. 
The distributable net income of both the portion of the trust which is a 
foreign trust created by a U.S. person and the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
for each year is computed in accordance with the provisions of paragraph 
(b)(3) of Sec. 1.643(d)-1 and the undistributed net income for each 
portion of the trust for each year is computed as described in paragraph 
(b) of Sec. 1.665(a)-1. For the taxable years 1952 through 1963, the 
portion of the trust which is a foreign trust created by a U.S. person 
and the portion of the trust which is a foreign trust created by a 
person other than a U.S. person had the following amounts of 
undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                             Undistributed net  
                                                                      Undistributed net      income--portion of 
                               Year                                   income--portion of    the trust created by
                                                                     the trust created by  a person other than a
                                                                        a U.S. person           U.S. person     
----------------------------------------------------------------------------------------------------------------
1963..............................................................           $20,000                $10,000     
1962..............................................................            25,000                 12,000     
1961..............................................................              None                   None     
1960..............................................................            16,000                  9,000     
1959..............................................................            17,000                  8,000     
1958..............................................................             4,000                  2,000     
1957..............................................................              None                   None     
1956..............................................................             8,000                  3,000     
1955..............................................................            11,000                  5,000     
1954..............................................................              None                   None     
1953..............................................................            12,000                  7,000     
1952..............................................................             7,000                  4,000     
                                                                   ---------------------------------------------
  Totals..........................................................           120,000                 60,000     
----------------------------------------------------------------------------------------------------------------

The accumulation distribution in the amount of $150,000 is deemed to 
have been distributed in the amount of $100,000 (120,000/
180,000 x $150,000) from the portion of the trust which is a foreign 
trust created by a U.S. person, and in the amount of $50,000 (60,000/
180,000 x $150,000) from the portion of the trust which is a foreign 
trust created by a person other than a U.S. person computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                Throwback to    
                                                                                             preceding years of 
                                                                         Throwback to      portion of the entire
                               Year                                   preceding years of    foreign trust which 
                                                                    foreign trust created     is not a foreign  
                                                                       by a U.S. person      trust created by a 
                                                                                                U.S. person     
----------------------------------------------------------------------------------------------------------------
1963..............................................................           $20,000                $10,000     
1962..............................................................            25,000                 12,000     
1961..............................................................              None                   None     
1960..............................................................            16,000                  9,000     
1959..............................................................            17,000                  8,000     
1958..............................................................             4,000                  2,000     
1957..............................................................              None                   None     
1956..............................................................             8,000                  3,000     
1955..............................................................            10,000                  5,000     
1954..............................................................              None                   None     
1953..............................................................              None                  1,000     
1952..............................................................              None                   None     
                                                                   ---------------------------------------------
  Totals..........................................................           100,000                 50,000     
----------------------------------------------------------------------------------------------------------------

Pursuant to paragraph (a)(3) of this section, the accumulation 
distribution in the amount of $100,000 from the portion of the trust 
which is a foreign trust created by a U.S. person is included in the 
beneficiary's gross income for 1964, as this amount represents 
undistributed net income of the trust for the trust's preceding taxable 
years which began after December 31, 1953, and ended after August 16, 
1954. The accumulation distribution in the amount of $50,000 from the 
portion of the trust which is a foreign trust created by a person other 
than a U.S. person is included in the beneficiary's gross income for 
1964 to the extent of the undistributed net income of the trust for the 
preceding 5 years. Accordingly, with respect to the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
only the undistributed net income for the years 1959 through 1963 which 
totals $39,000 is includible in the beneficiary's gross income for 1964. 
Thus, of the $150,000 distribution made in 1964, the beneficiary is 
required to include a total of $139,000 in his gross income for 1964.
    Example 4. Assume the same facts as in example 3 and, in addition, 
that by December 31, 1964, the undistributed net income for 1964 is 
determined to be $20,000, and that in accordance with the provisions of 
paragraph (b)(3) of Sec. 1.643(d)-1 and paragraph (b) of Sec. 1.665(a)-
1, $10,000 is allocated to the portion of the trust which is a foreign 
trust created by a U.S. person and $10,000 is allocated to the portion 
of the trust which is a foreign trust created by a person other than a 
U.S. person. On March 31, 1965, the trust makes an

[[Page 199]]

accumulation distribution of $25,000 to the U.S. beneficiary. For the 
taxable years 1952 through 1964, the portion of the trust which is a 
foreign trust created by a U.S. person and the portion of the trust 
which is a foreign trust created by a person other than a U.S. person 
had the following amounts of undistributed net income:

----------------------------------------------------------------------------------------------------------------
                                                                                             Undistributed net  
                                                                      Undistributed net      income--portion of 
                               Year                                   income--portion of    the trust created by
                                                                     the trust created by  a person other than a
                                                                        a U.S. person           U.S. person     
----------------------------------------------------------------------------------------------------------------
1964..............................................................           $10,000                $10,000     
1963..............................................................              None                   None     
1962..............................................................              None                   None     
1961..............................................................              None                   None     
1960..............................................................              None                   None     
1959..............................................................              None                   None     
1958..............................................................              None                   None     
1957..............................................................              None                   None     
1956..............................................................              None                   None     
1955..............................................................             1,000                   None     
1954..............................................................              None                   None     
1953..............................................................            12,000                  6,000     
1952..............................................................             7,000                  4,000     
                                                                   ---------------------------------------------
  Totals..........................................................            30,000                 20,000     
----------------------------------------------------------------------------------------------------------------

The accumulation distribution is deemed to have been distributed in the 
amount of $15,000 (30,000/50,000 x $25,000), from the portion of the 
trust which is a foreign trust created by a U.S. person, and in the 
amount of $10,000 (20,000/50,000 x $25,000) from the portion of the 
trust which is a foreign trust created by a person other than a U.S. 
person computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                                Throwback to    
                                                                                             preceding years of 
                                                                         Throwback to      portion of the entire
                               Year                                   preceding years of    foreign trust which 
                                                                    foreign trust created     is not a foreign  
                                                                        by U.S. person       trust created by a 
                                                                                                U.S. person     
----------------------------------------------------------------------------------------------------------------
1964..............................................................           $10,000                $10,000     
1963..............................................................              None                   None     
1962..............................................................              None                   None     
1961..............................................................              None                   None     
1960..............................................................              None                   None     
1959..............................................................              None                   None     
1958..............................................................              None                   None     
1957..............................................................              None                   None     
1956..............................................................              None                   None     
1955..............................................................             1,000                   None     
1954..............................................................              None                   None     
1953..............................................................             4,000                   None     
1952..............................................................              None                   None     
                                                                   ---------------------------------------------
  Totals..........................................................            15,000                 10,000     
----------------------------------------------------------------------------------------------------------------

Pursuant to paragraph (a)(3) of this section, only $11,000 of the 
accumulation distribution in the amount of $15,000 from the portion of 
the trust which is a foreign trust created by a U.S. person is 
includible in the beneficiary's gross income for 1965 as the $11,000 
amount represents undistributed net income of the trust for the trust's 
preceding taxable years which began after December 31, 1953, and ended 
after August 16, 1954. The accumulation distribution in the amount of 
$10,000 from the portion of the trust which is a foreign trust created 
by a person other than a U.S. person is included in the beneficiary's 
gross income for 1965 to the extent of the undistributed net income of 
the trust for the preceding 5 years. Accordingly, the entire $10,000 
(representing the undistributed net income for the year 1964) is 
includible in the beneficiary's gross income for 1965. Thus, of the 
$25,000 distribution made in 1965, the beneficiary is required to 
include a total of $21,000 in his gross income for 1965.

    (d) For the purposes of allocating to any preceding taxable year an 
accumulation distribution of the taxable year, the undistributed net 
income of such preceding taxable year is computed without regard to the 
accumulation distribution of the taxable year or of taxable years 
following the taxable year. However, accumulation distributions of any 
taxable years intervening between such preceding taxable year and the 
taxable year are taken into account. Accordingly, if a trust has 
undistributed net income for the taxable year 1954 and makes an 
accumulation distribution during the taxable year 1955, the 
undistributed net income for 1954 is computed without regard to the 
accumulation distribution for 1955 or any subsequent year. If the trust 
makes a further accumulation distribution for 1956, the undistributed 
net income for 1954 is computed without regard to the accumulation 
distribution for 1956 or subsequent years; but in determining the 
undistributed net income for 1954 for purposes of the 1956 accumulation 
distribution the accumulation distribution for 1955 will be taken into 
account.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
736, Jan. 17, 1969]

[[Page 200]]



Sec. 1.666(b)-1  Total taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1 
to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed net income for such preceding 
taxable year, then an additional amount equal to the ``taxes imposed on 
the trust'' (as defined in Sec. 1.665(d)-1) for such preceding taxable 
year is likewise deemed distributed under section 661(a)(2). For 
example, a trust has taxable income of $11,032 (not including any 
capital gains) and undistributed net income of $8,000 for the taxable 
year 1954. The taxes imposed on the trust are $3,032. During the taxable 
year 1955, an accumulation distribution of $8,000 is made to the 
beneficiary, which is deemed under Sec. 1.666(a)-1 to have been 
distributed on the last day of 1954. The taxes imposed on the trust for 
1954 of $3,032 are also deemed to have been distributed on the last day 
of 1954 since the 1955 accumulation distribution is not less than the 
1954 undistributed net income. Thus, a total of $11,032 will be deemed 
to have been distributed on the last day of 1954 because of the 
accumulation distribution of $8,000 made in 1955.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year is computed 
without regard to the accumulation distribution of the taxable year or 
any taxable year following such taxable year. However, any accumulation 
distribution of taxable years intervening between such preceding taxable 
year and the taxable year are taken into account. See paragraph (d) of 
Sec. 1.666(a)-1 and paragraphs (f)(5) and (g)(1) of Sec. 1.668(b)-2.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
741, Jan. 17, 1969]



Sec. 1.666(c)-1  Pro rata portion of taxes deemed distributed.

    (a) If an accumulation distribution is deemed under Sec. 1.666(a)-1 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such preceding 
taxable year, then an additional amount is likewise deemed distributed 
under section 661(a)(2). The additional amount is equal to the taxes 
imposed on the trust, as defined in Sec. 1.665(d)-1, for such preceding 
taxable year, multiplied by the fraction of which the numerator is the 
amount of the accumulation distribution and the denominator is the 
undistributed net income for such preceding taxable year. See paragraph 
(b) of example 1 and paragraphs (c) and (f) of example 2 in 
Sec. 1.666(c)-2, and paragraph (f)(2) of Sec. 1.668(b)-2 for 
illustrations of this paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed net income of any preceding taxable year is computed 
without regard to the accumulation distribution of the taxable year or 
any taxable year following the taxable year. However, accumulation 
distributions of any taxable years intervening between such preceding 
taxable year and the taxable year are taken into account. See paragraph 
(d) of Sec. 1.666(a)-1, paragraph (c) of example 1 and paragraphs (e) 
and (h) of example 2 in Sec. 1.666(c)-2 and paragraph (f)(5)(iii) of 
Sec. 1.668(b)-2.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
741, Jan. 17, 1969]



Sec. 1.666(c)-2   Illustration of the provisions of section 666.

    The application of the provisions of Secs. 1.666(a)-1, 1.666(b)-1, 
and 1.666(c)-1 may be illustrated by the following examples:

    Example 1. (a) A trust makes accumulation distributions as follows:

    1959..........................................................$7,000
    1960..........................................................25,000

For 1954 through 1958, the undistributed portion of distributable net 
income taxes imposed on the trust, and undistributed net income are as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                       Undistributed                            
                                                                        portion of        Taxes    Undistributed
                                Year                                   distributable   imposed on    net income 
                                                                        net income      the trust               
----------------------------------------------------------------------------------------------------------------
1958...............................................................     $12,100         $3,400        $8,700    
1957...............................................................      16,100          5,200        10,900    
1956...............................................................       6,100          1,360         4,740    
1955...............................................................        None           None          None    
1954...............................................................      10,100          2,640         7,460    
----------------------------------------------------------------------------------------------------------------

    (b) Since the entire amount of the accumulation distribution for 
1959 ($7,000), determined without regard to the accumulation 
distribution for 1960, is less than the undistributed net income for 
1958 ($8,700), an additional amount of $2,736 (7,000/ 8,700 x $3,400) is

[[Page 201]]

likewise deemed distributed under section 666(c).
    (c) In allocating the accumulation distribution for 1960, the 
undistributed net income for 1958 will take into account the 
accumulation distribution for 1959, and the additional amount of taxes 
imposed on the trust for 1958 deemed distributed. The undistributed net 
income for 1958 will then be $1,906; and the taxes imposed on the trust 
for 1958 will then be $458, determined as follows:

Undistributed portion of distributable net income as of the             
 close of 1958...............................................    $12,100
Less:                                                                   
  Accumulation distribution (1959)................     $7,000           
  Taxes deemed distributed under section 666(c)                         
   (7,000/8,700 x $3,400).........................      2,736           
                                                   -----------          
                                                                   9,736
                                                   ------------         
    Balance (undistributed portion of distributable net                 
     income as of the close of 1959).........................      2,364
Less: Personal exemption.....................................        100
                                                   ------------         
    Balance..................................................      2,264
Taxes imposed on the trust (income taxes on $2,264)..........        458
                                                   ------------         
Undistributed portion of distributable net income as of the             
 close of 1959...............................................      2,364
Less: Income taxes attributable thereto......................        458
                                                   ------------         
    Undistributed net income for 1958 as of the close of 1959      1,906
                                                                        

    (d) The accumulation distribution of $25,000 for 1960 is deemed to 
have been made on the last day of the 5 preceding taxable years of the 
trust to the extent of $17,546, the total of the undistributed net 
income for such years, as shown in the tabulation below. In addition, 
$7,018, the total taxes imposed on the trust for such years is also 
deemed to have been distributed on the last day of such years, as shown 
below:

------------------------------------------------------------------------
                                        Undistributed   Taxes imposed on
                Year                     net income         the trust   
------------------------------------------------------------------------
1959................................        None              None      
1958................................      $1,906              $458      
1957................................      10,900             5,200      
1956................................       4,740             1,360      
1955................................        None              None      
------------------------------------------------------------------------

    (e) No portion of the 1960 accumulation distribution is deemed made 
on the last day of 1954 because, as to 1960, 1954 is the sixth preceding 
taxable year.
    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The entire income of the trust is from 
royalties. Both X and the trust report on the calendar year basis. All 
of the income for 1954 was accumulated. The distributable net income of 
the trust for the taxable year 1954 is $20,100 and the income taxes paid 
by the trust for 1954 with respect to its distributable net income are 
$7,260. All of the income for 1955 and 1956 was distributed and in 
addition the trustee made accumulation distributions within the meaning 
of section 665(b) of $6,420 for each year.
    (b) The undistributed net income of the trust determined under 
section 665(a) as of the close of 1954, is $12,840, computed as follows:

Distributable net income....................................     $20,100
Less: Taxes imposed on the trust............................       7,260
                                                             -----------
    Undistributed net income as of the close of 1954........      12,840
                                                                        

    (c) The accumulation distribution of $6,420 made during the taxable 
year 1955 is deemed under section 666(a) to have been made on December 
31, 1954. Since this accumulation distribution is less than the 1954 
undistributed net income of $12,840, a portion of the taxes imposed on 
the trust for 1954 is also deemed under section 666(c) to have been 
distributed on December 31, 1954. The total amount deemed to have been 
distributed to X on December 31, 1954, is $10,050, computed as follows:

Accumulation distribution...................................      $6,420
Taxes deemed distributed (6,420/ 12,840 x $7,260)...........       3,630
                                                             -----------
    Total...................................................      10,050
                                                                        

    (d) After the application of the provisions of subpart D (section 
665 and following), part I, subchapter J, chapter 1 of the Code, to the 
accumulation distribution of 1955, the undistributed portion of the 
distributable net income of the trust for 1954, is $10,050, and the 
taxes imposed with respect thereto are $2,623, computed as follows:

Distributable net income as of the close of 1954............     $20,100
Less: 1955 accumulation distribution and taxes deemed                   
 distributed on December 31, 1954 (paragraph (c) of this                
 example)...................................................      10,050
                                                             -----------
    Undistributed portion of the 1954 distributable net                 
     income adjusted as of the close of 1955................      10,050
Less: Personal exemption....................................         100
                                                             -----------
    Balance.................................................       9,950
Income taxes on $9,950......................................       2,623
                                                                        

    (e) The undistributed net income of the trust for the taxable year 
1954, as adjusted to give effect to the 1955 accumulation distribution, 
is $7,427, computed as follows:

[[Page 202]]



Undistributed portion of distributable net income as of the             
 close of 1955..............................................     $10,050
Less: Income taxes applicable thereto.......................       2,623
                                                             -----------
    Undistributed net income determined as of the close of              
     1955...................................................       7,427
                                                                        

    (f) Inasmuch as all of the income of the trust for the taxable year 
1955 was distributed to X, the trust had no undistributed net income for 
that year. Accordingly, the accumulation distribution of $6,420 made 
during the taxable year 1956 is, under section 666(a), deemed a 
distribution to X on December 31, 1954, within the meaning of section 
661(a)(2). Since this accumulation distribution is less than the 1954 
adjusted undistributed net income of $7,427, the trust is deemed under 
section 666(c) also to have distributed on December 31, 1954, a portion 
of the taxes imposed on the trust for 1954. The total amount deemed to 
be distributed on December 31, 1954, with respect to the accumulation 
distribution made in 1956, is $8,687, computed as follows:

Accumulation distribution...................................      $6,420
Taxes deemed distributed (6,420/ 7,427 x $2,623)............       2,267
                                                             -----------
    Total...................................................       8,687
                                                                        

    (g) After the application of the provisions of subpart D to the 
accumulation distribution of 1956, the undistributed portion of the 
distributable net income of the trust for 1954, is $1,363, and the taxes 
imposed on the trust with respect thereto are $253, computed as follows:

Undistributed portion of distributable net income as of the             
 close of 1955..............................................     $10,050
Less: 1956 accumulation distribution and taxes deemed                   
 distributed on December 31, 1954 (paragraph (f) of this                
 example)...................................................       8,687
                                                             -----------
    Undistributed portion of distributable net income as of             
     the close of 1956......................................       1,363
Less: Personal exemption....................................         100
                                                             -----------
    Balance.................................................       1,263
Income taxes on $1,263......................................         253
                                                                        

    (h) The undistributed net income of the trust for the taxable year 
1954, determined as of the close of the taxable year 1956, is $1,110 
($1,363 less $253).



Sec. 1.667-1   Denial of refund to trusts.

    (a) If an amount is deemed under section 666 to be an amount paid, 
credited, or required to be distributed on the last day of a preceding 
taxable year, the trust is not allowed a refund or credit of the amount 
of ``taxes imposed on the trust'', as defined in Sec. 1.665(d)-1, which 
would not have been payable for the preceding taxable year had the trust 
in fact made such distribution on the last day of such year. However, 
such taxes are allowed as a credit under section 668(b) against the tax 
of the beneficiaries who are treated as having received the 
distributions in the preceding taxable year. The amount of taxes which 
may not be refunded or credited to the trust under this paragraph and 
which are allowed as a credit under section 668(b) against the tax of 
the beneficiaries, is an amount equal to the excess of:
    (1) The taxes imposed on the trust (as defined in section 665(d) and 
Sec. 1.655(d)-1) for any preceding taxable year (computed without regard 
to the accumulation distribution for the taxable year) over
    (2) The amount of taxes for such preceding taxable year which would 
be imposed on the undistributed portion of distributable net income of 
the trust for such preceding taxable year after the application of 
subpart D (section 665 and following), part I, subchapter J, chapter 1 
of the Code, on account of the accumulation distribution determined for 
the taxable year.

It should be noted that the credit under section 667 is computed by the 
use of a different ratio from that used for computing the amount of 
taxes deemed distributed under section 666(c).
    (b) Paragraph (a) of this section may be illustrated by the 
following examples:

    Example 1. In 1954, a trust of which A is the sole beneficiary has 
taxable income of $20,000 (including capital gains of $5,100 allocable 
to

[[Page 203]]

corpus less a personal exemption of $100), on which a tax of $7,260 is 
paid.

The undistributed portion of distributable net income is $15,000, to 
which $6,160 of the tax is allocable under section 665. The 
undistributed net income is therefore $8,840 ($15,000 minus $6,160). In 
1955, the trust makes an accumulation distribution of $8,840. Under 
section 666(b), the total taxes for 1954 attributable to the 
undistributed net income are deemed distributed, so $15,000 is deemed 
distributed. The amount of the tax which may not be refunded to the 
trust under section 667 and the credit to which A is entitled under 
section 668(b) is the excess of $6,160 over zero, since after the 
distribution and the application of subpart D there is no remaining 
undistributed portion of distributable net income for 1954.
    Example 2. The same trust as in example 1 of this paragraph 
distributes $5,000 in 1955, rather than $8,840. The amount of the tax 
which may not be refunded to the trust but which is available to A as a 
credit is $4,044, computed as follows:

Accumulation distribution in 1955............................     $5,000
Taxes deemed distributed under section 666(c) (5,000/8,840 x            
 $6,160).....................................................      3,484
                                                   ------------         
    Total amount deemed distributed out of the undistributed            
     portion of distributable net income.....................      8,484
                                                   ============         
Tax attributable to the undistributed portion of                        
 distributable net income ($15,000) before 1955 distribution            
 (see example 1 of this paragraph)...........................      6,160
Tax on $11,516 (taxable income of $20,000 minus                         
 $8,484, amount deemed distributed)...............     $3,216           
Tax on $5,000 (capital gains of $5,100, less                            
 personal exemption of $100, allocable to corpus).      1,100           
                                                   -----------          
Tax attributable to undistributed portion of distributable              
 net income after 1955 distribution..........................      2,116
                                                   ------------         
    Refund disallowed to the trust and credit available to A            
     in 1955.................................................      4,044
                                                                        

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
741, Jan. 17, 1969]



Sec. 1.667(a)-1A   Denial of refund to trusts.

    If an amount is deemed under section 666 or 669 to be an amount 
paid, credited, or required to be distributed on the last day of a 
preceding taxable year, the trust is not allowed a refund or credit of 
the amount of ``taxes imposed on the trust'', as defined in 
Sec. 1.665(d)-1A. However, such taxes imposed on the trust are allowed 
as a credit under section 667(b) against the tax of certain 
beneficiaries who are treated as having received the distributions in 
the preceding taxable year.

[T.D. 7204, 37 FR 17147, Aug. 25, 1972]



Sec. 1.667(b)-1A  Authorization of credit to beneficiary for taxes imposed on the trust.

    (a) Determination of credit--(1) In general. Section 667(b) allows 
under certain circumstances a credit (without interest) against the tax 
imposed by subtitle A of the Code on the beneficiary for the taxable 
year in which the accumulation distribution is required to be included 
in income under section 668(a). In the case of an accumulation 
distribution consisting only of undistributed net income, the amount of 
such credit is the total of the taxes deemed distributed to such 
beneficiary under section 666 (b) and (c) as a result of such 
accumulation distribution for preceding taxable years of the trust on 
the last day of which such beneficiary was in being, less the amount of 
such taxes for such preceding taxable years taken into account in 
reducing the amount of partial tax determined under Sec. 1.668(b)-1A. In 
the case of an accumulation distribution consisting only of 
undistributed capital gain, the amount of such credit is the total of 
the taxes deemed distributed as a result of the accumulation 
distribution to such beneficiary under section 669 (d) and (e) for 
preceding taxable years of the trust on the last day of which such 
beneficiary was in being, less the amount of such taxes for such 
preceding taxable years taken into account in reducing the amount of 
partial tax determined under Sec. 1.669(b)-1A. In the case of an 
accumulation distribution consisting of both undistributed net income 
and undistributed capital gain, a credit will not be available unless 
the total taxes deemed distributed to the beneficiary for all preceding 
taxable years as a result of the accumulation distribution exceeds the 
beneficiary's partial tax determined under Secs. 1.668(b)-1A and 
1.669(b)-1A without reference to the taxes deemed distributed. A credit 
is not allowed for any taxes deemed distributed as a result of an 
accumulation distribution to a beneficiary by

[[Page 204]]

reason of sections 666 (b) and (c) or sections 669 (d) and (e) for a 
preceding taxable year of the trust before the beneficiary was born or 
created. However, if as a result of an accumulation distribution the 
total taxes deemed distributed under sections 668(a)(2) and 668(a)(3) in 
preceding taxable years before the beneficiary was born or created 
exceed the partial taxes attributable to amounts deemed distributed in 
such years, such excess may be used to offset any liability for partial 
taxes attributable to amounts deemed distributed as a result of the same 
accumulation distribution in preceding taxable years after the 
beneficiary was born or created.
    (2) Exact method. In the case of the tax computed under the exact 
method provided in Secs. 1.668(b)-1A(b) and 1.669(b)-1A(b), the credit 
allowed by this section is computed as follows:
    (i) Compute the total taxes deemed distributed under Secs. 1.666(b)-
1A and 1.666(c)-1A or Secs. 1.669(d)-1A and 1.669(e)-1A, whichever are 
appropriate, for the preceding taxable years of the trust on the last 
day of which the beneficiary was in being.
    (ii) Compute the total of the amounts of tax determined under 
Sec. 1.668(b)-1A(b)(1) or Sec. 1.669(b)-1A(b) (1), whichever is 
appropriate, for the prior taxable years of the beneficiary in which he 
was in being.

If the amount determined under subdivision (i) of this subparagraph does 
not exceed the amount determined under subdivision (ii) of this 
subparagraph, no credit is allowable. If the amount determined under 
subdivision (i) of this subparagraph exceeds the amount determined under 
subdivision (ii) of this subparagraph, the credit allowable is the 
lesser of the amount of such excess or the amount of taxes deemed 
distributed to the beneficiary for all preceding taxable years to the 
extent that such taxes are not used in Sec. 1.668(b)-1A(b)(2) or 
Sec. 1.669(b)-1A(b)(2) in determining the beneficiary's partial tax 
under section 668(a)(2) or 668(a)(3). The application of this 
subparagraph may be illustrated by the following example:

    Example. An accumulation distribution made in 1975 is deemed 
distribution in 1973 and 1974, years in which the beneficiary was in 
being. The taxes deemed distributed in such years are $4,000 and $2,000, 
respectively, totaling $6,000. The amounts of tax computed under 
Sec. 1.668(b)-1A(b)(1) attributable to the amounts thrown back are 
$3,000 and $2,000, respectively, totaling $5,000. The credit allowable 
under this subparagraph is therefore $1,000 ($6,000 less $5,000).

    (3) Short-cut method. In the case of the tax computed under the 
short-cut method provided in Sec. 1.668(b)-1A(c) or Sec. 1.669(b)-1A(c), 
the credit allowed by this section is computed as follows:
    (i) Compute the total taxes deemed distributed in all preceding 
taxable years of the trust under Secs. 1.666(b)-1A and 1.666(c)-1A or 
Secs. 1.669(d)-1A and 1.669(e)-1A, whichever are appropriate.
    (ii) Compute the beneficiary's partial tax determined under either 
Sec. 1.668(b)- 1A(c)(1)(v) or Sec. 1.669(b)-1A (c)(1)(v), whichever is 
appropriate.

If the amount determined under subdivision (i) of this subparagraph does 
not exceed the amount determined under subdivision (ii) of this 
subparagraph, no credit is allowable. If the amount determined under 
subdivision (i) of this subparagraph exceeds the amount determined under 
subdivision (ii) of this subparagraph,
    (iii) Compute the total taxes deemed distributed under 
Secs. 1.666(b)-1A and 1.666(c)-1A or Secs. 1.669(d)-1A and 1.669(e)-1A, 
which are appropriate, for the preceding taxable years of the trust on 
the last day of which the beneficiary was in being.
    (iv) Multiply the amount by which subdivision (i) of this 
subparagraph exceeds subdivision (ii) of this subparagraph by a 
fraction, the numerator of which is the amount determined under 
subdivision (iii) of this subparagraph and the denominator of which is 
the amount determined under subdivision (i) of this subparagraph. The 
result is the allowable credit. The application of this subparagraph may 
be illustrated by the following example:

    Example. An accumulation distribution that consists only of 
undistributed net income is made in 1975. The taxes deemed distributed 
in the preceding years under Secs. 1.666(b)-1A and 1.666(c)-1A are 
$15,000. The amount determined under Sec. 1.668(b)-1A(c)(1)(v) is 
$12,000. The beneficiary was in being on the last day of all but one 
preceding taxable year in which the accumulation distribution was deemed 
made, and the taxes deemed distributed in those years was

[[Page 205]]

$10,000. Therefore, the excess of the subdivision (i) amount over the 
subdivision (ii) amount is $3,000, and is multiplied by 10,000/15,000, 
resulting in an answer of $2,000, which is the credit allowable when 
computed under the short-cut method.

    (b) Year of credit. The credit to which a beneficiary is entitled 
under this section is allowed for the taxable year in which the 
accumulation distribution (to which the credit relates) is required to 
be included in the income of the beneficiary under section 668(a). Any 
excess over the total tax liability of the beneficiary for such year is 
treated as an overpayment of tax by the beneficiary. See section 6401(b) 
and the regulations thereunder.

[T.D. 7204, 37 FR 17147, Aug. 25, 1972]



Sec. 1.668(a)-1A   Amounts treated as received in prior taxable years; inclusion in gross income.

    (a) Section 668(a) provides that the total of the amounts treated 
under sections 666 and 669 as having been distributed by the trust on 
the last day of a preceding taxable year of the trust shall be included 
in the income of the beneficiary or beneficiaries receiving them. The 
total of such amounts is includable in the income of each beneficiary to 
the extent the amounts would have been included under section 662 (a)(2) 
and (b) as if the total had actually been an amount properly paid by the 
trust under section 661 (a)(2) on the last day of such preceding taxable 
year. The total is included in the income of the beneficiary for the 
taxable year of the beneficiary in which such amounts are in fact paid, 
credited, or required to be distributed unless the taxable year of the 
beneficiary differs from the taxable year of the trust (see section 
662(c) and the regulations thereunder). The character of the amounts 
treated as received by a beneficiary in prior taxable years, including 
taxes deemed distributed, in the hands of the beneficiary is determined 
by the rules set forth in section 662(b) and the regulations thereunder.
    (b) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.
    (c) For purposes of applying section 668(a)(3), a trust shall be 
considered to be other than a ``trust which is not required to 
distribute all of its income currently'' for each taxable year prior to 
the first taxable year beginning after December 31, 1968, and ending 
after November 30, 1969, in which income is accumulated. Income will not 
be deemed to have been accumulated for purposes of applying section 
668(a)(3) in a year if the trustee makes a determination, as evidenced 
by a statement on the return, to distribute all of the trust's income 
for such year and also makes a good faith determination as to the amount 
of such income and actually distributed for such year the entire amount 
so determined. The term ``income,'' as used in the preceding two 
sentences, is defined in Secs. 1.643(b)-1 and 1.643(b)-2. Since, under 
such definitions, certain items may be included in distributable net 
income but are not, under applicable local law, ``income'' (as, for 
example, certain extraordinary dividends), a trust that has 
undistributed net income from such sources might still qualify as a 
trust that has not accumulated income. Also, for example, if a trust 
establishes a reserve for depreciation or depletion and applicable local 
law permits the deduction for such reserve in the computation of 
``income,'' amounts so added to the reserve do not constitute an 
accumulation of income. If a trust has separate shares, and any share 
accumulates income, all shares of the trust will be considered to have 
accumulated income for purposes of section 668(a)(3). Amounts retained 
by a trust or a portion of a trust that is subject to subpart E 
(sections 671-678) shall not be considered accumulated income.
    (d) See section 1302(a)(2)(B) to the effect that amounts included in 
the income of a beneficiary of a trust under section 668(a) are not 
eligible for income averaging.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]

[[Page 206]]



Sec. 1.668(a)-2A   Allocation among beneficiaries; in general.

    The portion of the total amount includible in income under 
Sec. 1.668(a)-1A which is includible in the income of a particular 
beneficiary is based upon the ratio determined under the second sentence 
of section 662(a)(2) for the taxable year (and not for the preceding 
taxable year). This section may be illustrated by the following example:

    Example. (a) Under the terms of a trust instrument, the trustee may 
accumulate the income or make distributions to A and B. The trustee may 
also invade corpus for the benefit of A and B. The distributable net 
income of the trust for taxable year 1975 is $10,000. The trust had 
undistributed net income for taxable year 1973, the first year of the 
trust, of $5,000, to which a tax of $1,100 was allocable. On May 1, 
1975, the trustee distributes $10,000 to A, and on November 29, 1975, he 
distributes $5,000 to B. Thus, of the total distribution of $15,000, A 
received two-thirds and B receives one-third.
    (b) For the purposes of determining the amounts includible in the 
beneficiaries' gross income for 1975, the trust is deemed to have made 
the following distributions:

Amount distributed out of 1975 income (distributable net                
 income).....................................................    $10,000
Accumulation distribution deemed distributed by the trust on            
 the last day of 1973 under section 666(a)...................      5,000
Taxes imposed on the trust attributable to the undistributed            
 net income deemed distributed under section 666(b)..........      1,100
                                                                        

    (c) A will include in his income for 1975 two-thirds of each item 
shown in paragraph (b) of this example. Thus, he will include in gross 
income $6,666.67 (10,000/15,000 x  $10,000) of the 1975 distributable 
net income of the trust as provided in section 662(a)(2) (which is not 
an amount includable in his income under Sec. 1.668(a)-1A(a)). He will 
include in his income $3,333.33 (10,000/15,000 x $5,000) of the 
accumulation distribution and $733.33 (10,000/15,000 x  $1,100) of the 
taxes imposed on the trust, as provided in section 668(a).
    (d) B will include in his income for 1975 one-third of each item 
shown in paragraph (b) of this example, computed in the manner shown in 
paragraph (c) of this example.
    (e) To the extent the total accumulation distribution consists of 
undistributed net income and undistributed capital gain, A and B shall 
be treated as receiving a pro rata share of each for the preceding 
taxable year 1973.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]



Sec. 1.668(a)-3A   Determination of tax.

    In a taxable year in which an amount is included in a beneficiary's 
income under Sec. 1.668(a)-1A(a), the tax on the beneficiary for such 
taxable year is determined only as provided in section 668 and consists 
of the sum of:
    (a) A partial tax computed on (1) the beneficiary's taxable income 
reduced by (2) an amount equal to the total amounts includible in his 
income under Sec. 1.668(a)-1A(a), at the rate and in the manner as if 
section 668 had not been enacted,
    (b) A partial tax determined as provided in Sec. 1.668(b)-1A, and
    (c) In the case of a beneficiary of a trust which is not required to 
distribute all of its income currently, a partial tax determined as 
provided in Sec. 1.669(b)-1A.

[T.D. 7204, 37 FR 17148, Aug. 25, 1972]



Sec. 1.668(b)-1A   Tax on distribution.

    (a) In general. The partial tax imposed on the beneficiary by 
section 668(a)(2) shall be the lesser of:
    (1) The tax computed under paragraph (b) of this section (the 
``exact'' method), or
    (2) The tax computed under paragraph (c) of this section (the 
``short-cut'' method),

except as provided in Sec. 1.668(b)-4A (relating to failure to furnish 
proper information) and paragraph (d) of this section (relating to 
disallowance of short-cut method). For purposes of this paragraph, the 
method used in the return shall be accepted as the method that produces 
the lesser tax. The beneficiary's choice of the two methods is not 
dependent upon the method that he uses to compute his partial tax 
imposed by section 668(a)(3).
    (b) Computation of partial tax by the exact method. The partial tax 
referred to in paragraph (a)(1) of this section is computed as follows:
    (1) First, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years. For purposes of this paragraph, 
the ``section 666 amounts'' for a preceding taxable year are the amounts 
deemed distributed under section 666(a) on the last day of the preceding 
taxable year, plus the amount of taxes deemed distributed on such day 
under section 666 (b) or (c). The tax attributable to such amounts in 
each prior taxable year of

[[Page 207]]

the beneficiary is the difference between the tax for such year computed 
with the inclusion of the section 666 amounts in the beneficiary's gross 
income and the tax for such year computed without including them in such 
gross income. Tax computations for each such year shall reflect a 
taxpayer's marital, dependency, exemption, and filing status for such 
year. To the extent the undistributed net income of a trust deemed 
distributed in an accumulation distribution includes amounts received as 
an accumulation distribution from another trust, for purposes of this 
paragraph they shall be considered as amounts deemed distributed by the 
trust under section 666(a) on the last day of each of the preceding 
taxable years in which such amounts were accumulated by such other 
trust. For example, assume trust Z, a calendar year trust, received in 
its taxable year 1975 an accumulation distribution from trust Y, a 
calendar year trust, that included undistributed net income and taxes of 
trust Y for the taxable years 1972, 1973, and 1974. To the extent an 
accumulation distribution made by trust Z in its taxable year 1976 
includes such undistributed net income and taxes, it shall be considered 
an accumulation distribution by trust Z in the taxable year 1976 and 
under section 666(a) will be deemed distributed on the last day of the 
preceding taxable years 1972, 1973, and 1974.
    (2) From the sum of the taxes for the prior taxable years 
attributable to the section 666 amounts (computed in accordance with 
subparagraph (1) of this paragraph), subtract so much of the amount of 
taxes deemed distributed to the beneficiary under Secs. 1.666(b)-1A and 
1.666(c)-1A as does not exceed such sum. The resulting amount, if any, 
is the partial tax, computed under the exact method, for the taxable 
year in which the accumulation distribution is paid, credited, or 
required to be distributed to the beneficiary.
    (3) The provisions of this paragraph may be illustrated by the 
following example:

    Example. (i) Assume that in 1979 a trust makes an accumulation 
distribution of $15,000 to A. The accumulation distribution is allocated 
under section 666(a) in the amounts of $5,000 to 1971, $4,000 to 1972, 
and $6,000 to 1973. Under section 666 (b) and (c), taxes in the amounts 
of $935, $715, and $1,155 (totaling $2,805) are deemed distributed in 
1971, 1972, and 1973, respectively.
    (ii) A, the beneficiary, had taxable income and paid income tax in 
1971-73 as follows:

------------------------------------------------------------------------
               Year                   Taxable income          Tax       
------------------------------------------------------------------------
1971..............................     $10,000             $2,190       
1972..............................      12,000              2,830       
1973..............................      14,000              3,550       
------------------------------------------------------------------------

    (iii) Taxes attributable to the section 666 amounts (paragraph (i) 
of this example) are $6,979, computed as follows:

                                  1971                                  
                                                                        
Taxable income including section 666 amounts                            
 ($10,000 + $5,000 + $935)........................    $15,935           
Tax on $15,935...............................................     $4,305
Less: Tax paid by A in 1971..................................      2,190
                                                   ------------         
Tax attributable to 1971 section 666 amounts.................      2,115
                                                                        
                                  1972                                  
                                                                        
Taxable income including section 666 amounts                            
 ($12,000 + $4,000 + $715)........................   $16,715            
Tax on $16,715...............................................     $4,620
Less: Tax paid by A in 1972..................................      2,830
                                                   ------------         
Tax attributable to 1972 section 666 amounts.................      1,790
                                                                        
                                  1973                                  
                                                                        
Taxable income including section 666 amounts                            
 ($14,000 + $6,000 + $1,155)......................    $21,155           
Tax on $21,155...............................................     $6,624
Less: Tax paid by A in 1973..................................      3,550
                                                   ------------         
Tax attributable to 1973 section 666 amounts.................      3,074
Total tax attributable to section 666 amounts:                          
  1971............................................     $2,115           
  1972............................................      1,790           
  1973............................................      3,074           
                                                   -----------          
    Total.........................................      6,979           
                                                                        

    (iv) The partial tax computed under the exact method is $4,174, 
computed by subtracting the taxes deemed distributed ($2,805) from the 
tax attributable to the section 666 amounts ($6,979).

    (c) Computation of tax by the short- cut method. (1) The tax 
referred to in paragraph (a)(2) of this section is computed as follows:
    (i) First, determine the number of preceding taxable years of the 
trust on the last day of which an amount is deemed under section 666(a) 
to have been distributed. For purposes of the preceding sentence, the 
preceding taxable years of a trust that has received an accumulation 
distribution from another trust shall include the taxable years of such 
other trust in which an

[[Page 208]]

amount was deemed distributed in such accumulation distribution. For 
example, assume trust Z, a calendar year trust, received in its taxable 
year 1975 an accumulation distribution from trust Y, a calendar year 
trust, that included undistributed net income of trust Y for the taxable 
years 1972, 1973, and 1974. To the extent an accumulation distribution 
made by trust Z in its taxable year 1976 includes such undistributed net 
income, it shall be considered an accumulation distribution by trust Z 
in the taxable year 1976 and under section 666(a) will be deemed 
distributed on the last day of the preceding taxable years 1972, 1973, 
and 1974. For purposes of this subparagraph, such number of preceding 
taxable years of the trust shall not include any preceding taxable year 
of the trust in which the undistributed net income deemed distributed is 
less than 25 percent of (a) the total amounts deemed under section 
666(a) to be undistributed net income from preceding taxable years 
divided by (b) the number of such preceding taxable years of the trust 
on the last day of which an amount is deemed under section 666(a) to 
have been distributed without application of this sentence. For example, 
assume that an accumulation distribution of $90,000 made to a 
beneficiary in 1979 is deemed distributed in the amounts of $29,000 in 
each of the years 1972, 1973, and 1974, and $3,000 in 1975. The number 
of preceding taxable years on the last day of which an amount was deemed 
distributed without reference to the second sentence of this 
subparagraph is four. However, the distribution deemed made in 1975 
($3,000) is less than $5,625, which is 25 percent of (a) the total 
undistributed net income deemed distributed under section 666(a) 
($90,000) divided by (b) the number of such preceding taxable years (4), 
or $22,500. Therefore, for purposes of this subparagraph the 
accumulation distribution is deemed distributed in only 3 preceding 
taxable years (1972, 1973, and 1974).
    (ii) Second, divide the amount (representing the accumulation 
distribution and taxes deemed distributed) required under section 668(a) 
to be included in the income of the beneficiary for the taxable year by 
the number of preceding taxable years of the trust on the last day of 
which an amount is deemed under section 666(a) to have been distributed 
(determined as provided in subdivision (i) of this subparagraph). The 
amount determined under this subdivision, including taxes deemed 
distributed, consists of the same proportion of each class of income as 
the total of each class of income deemed distributed in the accumulation 
distribution bears to the total undistributed net income from such 
preceding taxable years deemed distributed in the accumulation 
distribution. For example, assume that an amount of $50,000 is deemed 
distributed under section 666(a) from undistributed net income of 5 
preceding taxable years of the trust, and consists of $25,000 of 
interest, $15,000 of dividends, and $10,000 of net rental income. Taxes 
attributable to such amounts in the amount of $10,000 are also deemed 
distributed. The amount determined under this subdivision, $12,000 
($50,000 income plus $10,000 tax divided by 5 years), is deemed to 
consist of $6,000 in interest, $3,600 in dividends, and $2,400 in net 
rental income.
    (iii) Third, compute the tax of the beneficiary for each of the 3 
taxable years immediately preceding the year in which the accumulation 
distribution is paid, credited, or required to be distributed to him,
    (a) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subdivision (ii) of this 
subparagraph, and
    (b) Without such inclusion.

The difference between the amount of tax computed under (a) of this 
subdivision for each year and the amount computed under (b) of this 
subdivision for that year is the additional tax resulting from the 
inclusion in gross income for that year of the amount determined under 
subdivision (ii) of this subparagraph. For example, assume that a 
distribution of $12,000, is includible in the income of each of the 
beneficiary's 3 preceding taxable years when his income (without the 
inclusion of the accumulation distribution) was $20,000, $30,000, and 
$40,000. The inclusion of $12,000 in income would produce taxable income 
of $32,000, $42,000, and $52,000, and the tax attributable to such

[[Page 209]]

increases would be $4,000, $5,000, and $6,000, respectively.
    (iv) Fourth, add the additional taxes resulting from the application 
of subdivision (iii) of this subparagraph and then divide this amount by 
3. For example, if these additional taxes are $4,000, $5,000, and $6,000 
for the 3 preceding taxable years, this amount would be $5,000 
($4,000+$5,000+ $6,000 divided by 3).
    (v) Fifth, the resulting amount is then multiplied by the number of 
preceding taxable years of the trust on the last day of which an amount 
is deemed under section 666(a) to have been distributed (previously 
determined under subdivision (i) of this subparagraph). For example, if 
an amount is deemed distributed for 5 preceding taxable years, the 
resulting amount would be five times the $5,000 amount.
    (vi) Sixth, the resulting amount, less so much of the amount of 
taxes deemed distributed to the beneficiary under Secs. 1.666(b)-1A and 
1.666(c)-1A as does not exceed such resulting amount, is the tax under 
the short-cut method provided in section 668(b)(1)(B).
    (2) The computation of the tax by the short-cut method may be 
illustrated by the following example:

    Example: In 1971, X creates a trust which is to accumulate its 
income and pay the income to Y when Y reaches 30. Y is 19. Over the 11 
years of the trust, the trust earns $1,200 of interest income annually 
and has expenses each year of $100 allocable to the production of 
income. The trust pays a total tax of $1,450 on the accumulated income. 
In 1981, when Y reaches 30, the $9,550 of accumulated undistributed net 
income and the $1,100 of current net income are distributed to Y. Y is 
treated as having received a total distribution of $11,000 (the $9,550 
accumulation distribution plus the taxes paid by the trust which are 
deemed to have been distributed to Y). The income of the current year 
(1981) is taxed directly to Y. The computation is as follows: $11,000 
(accumulation distribution plus taxes) divided by 10 (number of years 
out of which distribution was made) equals $1,100. The $1,100 added to 
the income of the beneficiary's preceding 3 years produces increases in 
tax as follows:

  1980................................................       $350       
  1979................................................        300       
  1978................................................        250       
                                                       -----------------
    Total.............................................        900       
                                                                        

$900 (total additional tax) divided by 3 equals $300 (average annual 
increase in tax). $300 (average annual increase in tax) times 10 equals 
$3,000, from which is deducted the amount of taxes ($1,450) paid by the 
trust attributable to the undistributed net income deemed distributed. 
The amount of tax to be paid currently under the short-cut method is 
therefore $1,550.

    (d) Disallowance of short-cut method. If, in any prior taxable year 
of the beneficiary in which any part of the accumulation distribution of 
undistributed net income is deemed to have been distributed under 
section 666(a) to such beneficiary, any part of prior accumulation 
distributions of undistributed net income by each of two or more other 
trusts is deemed under section 666(a) to have been distributed to such 
beneficiary, then the short-cut method under paragraph (c) of this 
section may not be used and the partial tax imposed by section 668(a)(2) 
shall be computed only under the exact method under paragraph (b) of 
this section. For example, assume that, in 1978, trust X makes an 
accumulation distribution of undistributed net income to A, who is on 
the calendar year basis, and part of the accumulation distribution is 
deemed under section 666(a) to have been distributed on March 31, 1974. 
In 1977, A had received an accumulation distribution of undistributed 
net income from both trust Y and trust Z. Part of the accumulation 
distribution from trust Y was deemed under section 666(a) to have been 
distributed to A on June 30, 1974, and part of the accumulation 
distribution from trust Z was deemed under section 666(a) to have been 
distributed to A on December 31, 1974. Because there were portions of 
accumulation distributions of undistributed net income from two other 
trusts deemed distributed within the same prior taxable year of A 
(1974), the 1978 accumulation distribution from trust X may not be 
computed under the short-cut method provided in paragraph (c) of this 
section. Therefore the exact method under paragraph (b) of this section 
must be used to compute the tax imposed by section 666(a)(2).

[T.D. 7204, 37 FR 17149, Aug. 25, 1972]

[[Page 210]]



Sec. 1.668(b)-2A   Special rules applicable to section 668.

    (a) Rule when beneficiary not in existence on the last day of a 
taxable year. If a beneficiary was not in existence on the last day of a 
preceding taxable year of the trust with respect to which a distribution 
is deemed made under section 666(a), it shall be assumed, for purposes 
of the computations under paragraphs (b) and (c) of Sec. 1.668(b)-1A, 
that the beneficiary:
    (1) Was in existence on such last day,
    (2) Was a calendar year taxpayer,
    (3) Had no gross income other than the amounts deemed distributed to 
him from such trust in his calendar year in which such last day occurred 
and from all other trusts from which amounts are deemed to have been 
distributed to him in such calendar year,
    (4) If an individual, was unmarried and had no dependents,
    (5) Had no deductions other than the standard deduction, if 
applicable, under section 141 for such calendar year, and
    (6) Was entitled to the personal exemption under section 151 or 
642(b).

For example, assume that part of an accumulation distribution made in 
1980 is deemed under section 666(a) to have been distributed to the 
beneficiary, A, in 1973; $10,000 of a prior accumulation distribution 
was deemed distributed in 1973. A was born on October 9, 1975. It will 
be assumed for purposes of Sec. 1.668(b)-1A that A was alive in 1973, 
was on the calendar year basis, had no income other than (i) the $10,000 
from the earlier accumulation distribution deemed distributed in 1973, 
and (ii) the part of the 1980 distribution deemed distributed in 1973, 
and had no deductions other than the personal exemption provided in 
section 151. It should be noted that the standard deduction for 1973 
will be available to A with respect to the distribution only to the 
extent it qualifies as ``earned income'' in the hands of the trust. See 
section 141(e) and the regulations thereunder and Sec. 1.652(b)-1. If A 
were a trust or estate created after 1973, the same assumptions would 
apply, except that the trust or estate would not be entitled to the 
standard deduction and would receive the personal exemption provided 
under section 642(b) in the same manner as allowed under such section 
for A's first actual taxable year.
    (b) Effect of other distributions. The income of the beneficiary, 
for any of his prior taxable years for which a tax is being recomputed 
under Sec. 1.668(b)-1A, shall include any amounts of prior accumulation 
distributions (including prior capital gain distributions) deemed 
distributed under sections 666 and 669 in such prior taxable year. For 
purposes of the preceding sentence, a ``prior accumulation 
distribution'' is a distribution from the same or another trust which 
was paid, credited, or required to be distributed in a prior taxable 
year of the beneficiary. The term ``prior accumulation distribution'' 
also includes accumulation distributions of other trusts which were 
paid, credited, or required to be distributed to the beneficiary in the 
same taxable year and which the beneficiary has determined under 
paragraph (c) of this section to treat as having been distributed before 
the accumulation distribution for which tax is being computed under 
Sec. 1.668(b)-1A. Any capital gain distribution from the same trust 
paid, credited, or required to be distributed in the same taxable year 
of the beneficiary shall not be considered under this paragraph to be a 
``prior capital gain distribution.''
    (c) Multiple distributions in the same taxable year. For purposes of 
paragraph (b) of this section, accumulation distributions made from more 
than one trust in the same taxable year of the beneficiary, regardless 
of when in the taxable year they were actually made, shall be treated as 
having been made consecutively, in whichever order the beneficiary may 
determine. However, the beneficiary must treat them as having been made 
in the same order for the purpose of computing the partial tax on the 
several accumulation distributions. The beneficiary shall indicate the 
order he has determined to deem the accumulation distributions to have 
been received by him on his return for the taxable year. A failure by 
him so to indicate, however, shall not affect his right to make such 
determination. The purpose of this rule is to assure that the tax 
resulting from the later (as so deemed under this paragraph) 
distribution is computed with

[[Page 211]]

the inclusion of the earlier distribution in the taxable base and that 
the tax resulting from the earlier (as so deemed under this paragraph) 
distribution is computed with the later distribution excluded from the 
taxable base.
    (d) Examples. The provisions of paragraphs (b) and (c) of this 
section may be illustrated by the following examples:

    Example 1. In 1978, trust X made an accumulation distribution of 
undistributed net income to A, a calendar year taxpayer, of which $3,000 
was deemed to have been distributed in 1974. In 1980, trust X makes 
another accumulation distribution of undistributed net income to A, 
$10,000 of which is deemed under section 666 to have been distributed in 
1974. Also in 1980, trust Y makes an accumulation distribution of 
undistributed net income to A, of which $5,000 is deemed under section 
666 to have been distributed in 1974. A determines to treat the 1980 
distribution from trust Y as having been made prior to the 1980 
distribution from trust X. In computing the tax on the 1980 trust Y 
distribution, A's gross income for 1974 includes (i) the $3,000 deemed 
distributed from the 1978 distribution, and (ii) the $5,000 deemed 
distributed in 1974 from the 1980 trust Y accumulation distribution. To 
compute A's tax under the exact method for 1974 on the $10,000 from the 
1980 trust X accumulation distribution deemed distributed in 1974, A's 
gross income for 1974 includes (i) the $10,000, (ii) the $3,000 
previously deemed distributed in 1974 from the 1978 trust X accumulation 
distribution, and (iii) the $5,000 deemed distribution in 1974 from the 
1980 trust Y accumulation distribution.
    Example 2. In 1978, trust T makes an accumulation distribution of 
undistributed net income to B, a calendar year taxpayer. Determination 
of the tax on the accumulation distribution under the short-cut method 
requires the use of B's gross income for 1975, 1976, and 1977. In 1977, 
B received an accumulation distribution of undistributed net income from 
trust U, of which $2,000 was deemed to have been distributed in 1975, 
and $3,000 in 1976. B's gross income for 1975, for purposes of using the 
short-cut method to determine the tax from the trust T accumulation 
distribution, will be deemed to include the $2,000 deemed distributed in 
1975 by trust U, and his gross income for 1976 will be deemed to include 
the $3,000 deemed distributed by trust U in 1976.

[T.D. 7204, 37 FR 17151, Aug. 25, 1972]



Sec. 1.668(b)-3A  Computation of the beneficiary's income and tax for a prior taxable year.

    (a) Basis for computation. (1) The beneficiary's income and tax paid 
for any prior taxable year for which a recomputation is involved under 
either the exact method or the short-cut method shall be determined by 
reference to the information required to be furnished by him under 
Sec. 1.668(b)- 4A(a). The gross income, related deductions, and taxes 
paid for a prior taxable year of the beneficiary as finally determined 
shall be used for computation purposes. The term ``as finally 
determined'' has reference to the final status of the gross income, 
deductions, credits, and taxes of the taxable year after the expiration 
of the period of limitations or after completion of any court action 
regarding the tax for the taxable year.
    (2) If any computations rely on the beneficiary's return for a prior 
taxable year for which the applicable period of limitations on 
assessment under section 6501 has expired, and such return shows a 
mathematical error on its face which resulted in the wrong amount of tax 
being paid for such year, the determination of both the tax for such 
year computed with the inclusion of the section 666 amount in the 
beneficiary's gross income and the tax for such year computed without 
including such amounts in such gross income shall be based upon the 
return after the correction of such mathematical errors, and the 
beneficiary shall be credited for the correct amount of tax that should 
have been properly paid.
    (b) Effect of allocation of undistributed net income on items based 
on amount of income and with respect to a net operating loss, a 
charitable contributions carryover, or a capital loss carryover. (1) In 
computing the tax for any taxable year under either the exact method or 
the short-cut method, any item which depends upon the amount of gross 
income, adjusted gross income, or taxable income shall be recomputed to 
take into consideration the amount of undistributed net income allocated 
to such year. For example, if $1,000 of undistributed net income is 
allocated to 1970, adjusted gross income for 1970 is

[[Page 212]]

increased from $5,000 to $6,000. The allowable 50 percent charitable 
deduction under section 170(b)(1)(A) is then increased and the amount of 
the nondeductible medical expenses under section 213 (3 percent of 
adjusted gross income) is also increased.
    (2) In computing the tax attributable to the undistributed net 
income deemed distributed to the beneficiary in any of his prior taxable 
years under either the exact method or the short-cut method, the effect 
of amounts of undistributed net income on a net operating loss carryback 
or carryover, a charitable contributions carryover, or a capital loss 
carryback or carryover, shall be taken into account. In determining the 
amount of tax attributable to such deemed distribution, a computation 
shall also be made for any taxable year which is affected by a net 
operating loss carryback or carryover, by a charitable contributions 
carryover, or by a capital loss carryback or carryover determined by 
reference to the taxable year to which amounts are allocated under 
either method and which carryback or carryover is reduced or increased 
by such amounts so allocated. The provisions of this subparagraph may be 
illustrated by the following example:

    Example. In 1978, a trust makes an accumulation distribution of 
undistributed net income to X of $50,000 that is deemed under section 
666(a) to have been distributed in 1972. X had income in 1972, 1973, and 
1973, and had a net operating loss in 1975 that offset his taxable 
income (computed as provided in Sec. 1.172-5) for those years, as 
follows:

------------------------------------------------------------------------
                                                      Income after net  
                                     Actual income     operating loss   
               Year                    (or loss)          carryback     
                                                        (n.o.l.c.b.)    
------------------------------------------------------------------------
1972..............................     $10,000                  $0      
1973..............................      50,000                   0      
1974..............................      50,000              10,000      
1975..............................   (100,000)                   0      
------------------------------------------------------------------------

    As a result of the allocation of the 1973 accumulation distribution 
to 1972, X's income for 1972, 1973, 1974, and 1975, after taking into 
account the 1975 n.o.l.c.b., is deemed to be as follows:

------------------------------------------------------------------------
                                           Income deemed to have been   
                                          earned after consideration of 
                 Year                     n.o.l.c.b., and accumulation  
                                                  distribution          
------------------------------------------------------------------------
1972..................................  0 ($10,000+$50,000-$60,000      
                                         n.o.l.c.b.).                   
1973..................................  $10,000 ($50,000-$40,000 balance
                                         of n.o.l.c.b.).                
1974..................................  $50,000.                        
1975..................................  0.                              
------------------------------------------------------------------------

    Therefore, the tax on the 1978 accumulation distribution to X is the 
tax X would have paid in 1973 and 1974 had he had the above income in 
such years.

    (c) Averaging. A beneficiary who uses the exact method may recompute 
his tax for a prior taxable year by using income averaging for all of 
his actual income for that year, plus the amount deemed distributed in 
that year under section 666, even though he may not have actually used 
section 1301 to determine his income tax for such taxable year. For 
purposes of such recomputation, the beneficiary's income for all other 
taxable years involved must include any amounts deemed distributed in 
such years from the current and all prior accumulation distributions. 
See Sec. 1.668(b)-4A(c)(3) for additional information requirements. The 
beneficiary may not apply the provisions of this paragraph to a taxable 
year in which an amount is deemed to be income by reason of 
Sec. 1.666(d)-1A(b). The accumulation distribution itself is not 
eligible for income averaging in the years in which it is paid, 
credited, or required to be distributed. See section 1302 (a)(2)(B) and 
the regulations thereunder.

[T.D. 7204, 37 FR 17151, Aug. 25, 1972]



Sec. 1.668(b)-4A   Information requirements with respect to beneficiary.

    (a) Information to be supplied by beneficiary--(1) In general. The 
beneficiary must supply the information required by subparagraph (3) of 
this paragraph for any prior taxable year for which a recomputation is 
required under either the exact method or the short-cut method. Such 
information shall be filed with the beneficiary's return for the year in 
which the tax under section 668(a)(2) is imposed.
    (2) Failure to furnish. If the beneficiary fails to furnish the 
information required by this paragraph for any prior year involved in 
the exact method, he may not use such method and

[[Page 213]]

the tax computed under paragraph (c) of Sec. 1.668(b)-1A (the short-cut 
method) shall be deemed to be the amount of partial tax imposed by 
section 668(a)(2). See, however, paragraph (b) of this section for an 
exception to this rule where the short-cut method is not permitted. If 
he cannot furnish the information required for a prior year involved in 
the short-cut method, such year will be recomputed on the basis of the 
best information available.
    (3) Information required. The beneficiary shall file the following 
items with his income tax return for the taxable year in which the 
accumulation distribution is included in income:
    (i) A statement showing the gross income, adjustments, deductions, 
credits, taxes paid, and computations for each of his taxable years for 
which a computation is required under the method by which he computes 
his partial tax imposed by section 668(a)(2). Such statement shall 
include such amounts for the taxable year as adjusted by any events 
subsequent to such year, such as any adjustment resulting from the 
determination of a deficiency or an overpayment, or from a court action 
regarding the tax.
    (ii) A copy of the statement required by this subparagraph to be 
furnished by the beneficiary for any prior taxable year in which an 
accumulation distribution was received by him which was also deemed 
distributed in whole or in part in the prior taxable year for which the 
statement under subdivision (i) of this subparagraph is required.
    (iii) A copy of any statements furnished the beneficiary by the 
trustee (such as schedules E and J of Form 1041, etc.) with regard to 
the current taxable year or any prior taxable year for which a statement 
is furnished under subdivision (i) of this subparagraph.
    (b) Exception. If by reason of Sec. 1.668(b)-1A(e) the beneficiary 
may not compute the partial tax on the accumulation distribution under 
Sec. 1.668(b)-1A(c) (the short-cut method), the provisions of 
subparagraph (2) of paragraph (a) of this section shall not apply. In 
such case, if the beneficiary fails to provide the information required 
by subparagraph (3) of paragraph (a) of this section for any prior 
taxable year, the district director shall, by utilizing whatever 
information is available to him (including information supplied by the 
beneficiary), determine the beneficiary's income and related expenses 
for such prior taxable year.
    (c) Records to be supplied by the beneficiary--(1) Year when return 
was filed. If the beneficiary filed an income tax return for a taxable 
year for which a recomputation is necessary, and the period of 
limitations on assessment under section 6501 for such year has expired 
as of the filing of the return for the year in which the accumulation 
distribution was made, then a copy of such return, plus proof of any 
changes of liability for such year due to the determination of a 
deficiency or an overpayment, court action, etc., shall, to the extent 
they verify the statements required under paragraph (a) of this section, 
serve as proof of such statements. If the period of limitations on 
assessment under section 6501 for a prior taxable year has not expired 
as of the filing of the beneficiary's return for the year in which the 
accumulation distribution was received, then the records required by 
section 6001 to be retained by the beneficiary for such prior taxable 
year shall serve as the basis of proof of the statements required to be 
filed under paragraph (a) of this section.
    (2) Year for which no return was filed. If the beneficiary did not 
file a return for a taxable year for which a recomputation is necessary, 
he shall be deemed to have had in such year, in the absence of proof to 
the contrary, gross income in the amount equal to the maximum amount of 
gross income that he could have received without having had to file a 
return under section 6012 for such year.
    (3) Distributions deemed averaged. In order for a beneficiary to use 
income averaging with respect to a prior taxable year (see 
Sec. 1.668(b)-3A(c)), he must furnish all the information that would 
support the computation under section 1301 as if the distribution were 
actually received and averaged in such prior taxable year, even if a 
portion of the information relates to years in which no amount was 
deemed distributed to the beneficiary.

[T.D. 7204, 37 FR 17152, Aug. 25, 1972]

[[Page 214]]



Sec. 1.668(a)-1  Amounts treated as received in prior taxable years; inclusion in gross income.

    (a) Section 668(a) provides that the total of the amounts treated 
under section 666 as having been distributed by the trust on the last 
day of a preceding taxable year of the trust shall be included in the 
gross income of the beneficiary or beneficiaries receiving them. The 
total of such amounts is includible in the gross income of each 
beneficiary to the extent the amounts would have been included under 
section 662 (a)(2) and (b) if the total had actually been paid by the 
trust on the last day of such preceding taxable year. The total is 
included in the gross income of the beneficiary for the taxable year of 
the beneficiary in which such amounts are in fact paid, credited, or 
required to be distributed unless the taxable year of the beneficiary 
differs from the taxable year of the trust (see section 662(c) and the 
regulations thereunder). The character of the amounts treated as 
received by a beneficiary in prior taxable years, including taxes deemed 
distributed, in the hands of the beneficiary is determined by the rules 
set forth in section 662(b) and the regulations thereunder. See 
paragraphs (h)(1)(ii) and (j)(1)(ii) of Sec. 1.668(b)-2.
    (b) The total of the amounts treated under section 666 as having 
been distributed by the trust on the last day of a preceding taxable 
year of the trust are included as prescribed in paragraph (a) of this 
section in the gross income of the beneficiary even though as of that 
day the beneficiary would not have been entitled to receive them had 
they actually been distributed on that day.
    (c) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.



Sec. 1.668(a)-2  Allocation among beneficiaries; in general.

    The portion of the total amount includible in gross income under 
Sec. 1.668 (a)-1 which is includible in the gross income of a particular 
beneficiary is based upon the ratio determined under the second sentence 
of section 662(a)(2) for the taxable year (and not for the preceding 
taxable year). This section may be illustrated by the following example:

    Example. (a) Under the terms of a trust instrument, the trustee may 
accumulate the income or make distributions to A and B. The trustee may 
also invade corpus for the benefit of A and B. The distributable net 
income of the trust for the taxable year 1955 is $10,000. The trust had 
undistributed net income for the taxable year 1954 of $5,000, to which a 
tax of $1,100 was allocable. During the taxable year 1955, the trustee 
distributes $10,000 to A and $5,000 to B. Thus, of the total 
distribution of $15,000, A received two-thirds and B received one-third.
    (b) For the purposes of determining the amounts includible in the 
beneficiaries' gross income for 1955, the trust is deemed to have made 
the following distributions:

Amount distributed out of 1955 income (distributable net                
 income).....................................................    $10,000
Accumulation distribution deemed distributed by the trust on            
 the last day of 1954 under section 666(a)...................      5,000
Taxes imposed on the trust deemed distributed under section             
 666(b)......................................................      1,100
                                                                        

    (c) A will include in his gross income for 1955 two-thirds of each 
item shown in paragraph (b) of this example. Thus, he will include in 
gross income $6,666.67 (10,000/ 15,000 x $10,000) of the 1955 
distributable net income of the trust as provided in section 662(a)(2), 
and $3,333.33 (10,000/ 15,000 x $5,000) of the accumulation distribution 
and $733.33 (10,000/15,000 x $1,100) of the taxes imposed on the trust 
as provided in section 668(a).
    (d) B will include in his gross income for 1955 one-third of each 
item shown in paragraph (b) of this example, computed in the manner 
shown in paragraph (c) of this example.



Sec. 1.668(a)-3  Excluded amounts.

    When a trust pays, credits, or is required to distribute to a 
beneficiary amounts which are excluded under section 665(b) (1), (2), 
(3), or (4) from the computation of an accumulation distribution, the 
amount includible under subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, in the gross income of the 
beneficiaries pursuant to Sec. 1.668(a)-1 is first allocated to the 
beneficiaries as provided in Sec. 1.668(a)-2 and, second, the

[[Page 215]]

amount allocable to the beneficiary receiving amounts which are excluded 
under section 665(b) (1), (2), (3), or (4) is reduced by the excluded 
amounts. This section may be illustrated by the following examples, in 
which it is assumed the trusts and beneficiaries report on the calendar 
year basis and the income of the trusts was derived entirely from 
taxable interest:

    Example 1. (a) A trust in 1957 has income as defined in section 
643(b) of $35,000 and expenses allocable to corpus of $5,000. Its 
distributable net income is, therefore, $30,000 ($35,000-$5,000). The 
undistributed net income of the trust and the taxes imposed on the trust 
were $12,840 and $7,260, respectively, for each of the years 1956, 1955, 
and 1954. The terms of the trust instrument provide for the accumulation 
of income during the minority of beneficiaries A and B. However, the 
trustee may make discretionary distributions to either beneficiary after 
he becomes 21 years of age. Also, the trustee may invade corpus for the 
benefit of A and B. B became 21 years of age on January 1, 1957, and, as 
of that date, A was 25 years old. The trustee distributed $50,000 each 
to A and B during 1957.
    (b) Since each beneficiary received one-half of the total amount 
distributed by the trust, each must include in gross income under 
section 662(a)(2) one-half ($15,000) of the distributable net income 
($30,000) of the trust for 1957.
    (c) The excess distribution of $35,000 ($50,000-$15,000) received by 
B is excluded from the determination of an accumulation distribution 
under section 665(b)(1) and accordingly is not includible in B's gross 
income under section 668(a). Nor is such amount treated as an 
accumulation distribution for the purpose of determining the amount 
includible in A's gross income under section 668(a).
    (d) The accumulation distribution of the trust is $35,000, computed 
as follows:

Total distribution by the trust.................  ..........    $100,000
Less:                                                                   
  Distributable net income for 1957.............     $30,000            
  Excess distribution to B......................      35,000            
                                                 ------------           
                                                                  65,000
                                                 -------------          
    Accumulation distribution to A..........................      35,000
                                                                        

    (e) The accumulation distribution of $35,000 will be allocated to 
the preceding taxable years 1956, 1955, and 1954, and the trust will be 
deemed to have made the following distributions to A on the last day of 
those years:

------------------------------------------------------------------------
                                 1956       1955       1954      Total  
------------------------------------------------------------------------
Undistributed net income....    $12,840    $12,840     $9,320    $35,000
Taxes imposed on the trust..      7,260      7,260      5,270     19,790
                             -------------------------------------------
Total.......................     20,100     20,100     14,590     54,790
------------------------------------------------------------------------

Thus, A will include $54,790 in his gross income for 1957 under section 
668(a). A will, however, receive credit against his tax under section 
668(b).
    Example 2. (a) Under the terms of a trust the trustee may make 
discretionary distributions out of income to A during her life. The 
balance of the income is to be accumulated during the minority of her 
son, B, and is to be distributed to him when he becomes 21 years of age. 
Thereafter the trustee may also make discretionary payments of income to 
B. Also, the trustee may invade corpus for the benefit of A and B. B 
became 21 years of age on December 31, 1955. The distributable net 
income of the trust for 1955 is $30,000. It had undistributed net income 
of $12,840 for the preceding taxable year 1954 and the taxes imposed on 
the trust for such year were $7,260. The trustee distributed $15,000 to 
A during 1955 and on December 31, 1955, he distributed $60,000 to B, 
which represented income accumulated during his minority.
    (b) Since B received four-fifths of the total amount ($75,000) 
distributed by the trust during 1955, he must include in his gross 
income under section 662(a)(2) four-fifths ($24,000) of the 
distributable net income ($30,000) of the trust for 1955. A will include 
in her gross income under section 662(a)(2) one-fifth ($6,000) of the 
distributable net income ($30,000) of the trust for 1955.
    (c) The excess distribution of $36,000 ($60,000-$24,000) received by 
B is excluded from the determination of an accumulation distribution 
under section 665(b)(1) and accordingly is not includible in his gross 
income under section 668(a).
    (d) The amount treated as an accumulation distribution for the 
purpose of determining the amount includible in A's gross income for 
1955 under section 668(a) is $9,000, computed as follows:

Total distribution by the trust.................  ..........     $75,000
Less:                                                                   
  Distributable net income for 1955.............     $30,000            
  Excess distribution to B......................      36,000            
                                                 -------------          
                                                                  66,000
                                                 -------------          
    Amount treated as an accumulation distribution..........       9,000
                                                                        

    (e) Inasmuch as the amount of $9,000 is less than the total 
undistributed net income of the trust ($12,840) for the preceding 
taxable

[[Page 216]]

year 1954, a pro rata portion of the taxes imposed on the trust for that 
year are also deemed distributed by the trust. Thus, A will include 
$14,089 in her gross income for 1955 under section 668 (a) computed as 
follows:

                                  1954                                  
Accumulation distribution...................................      $9,000
Taxes imposed on the trust (9,000/ 12,840 x $7,260).........       5,089
                                                 -------------          
    Total...................................................      14,089
                                                                        

A will, however, receive credit against her tax under section 668(b).



Sec. 1.668(a)-4  Tax attributable to throwback.

    (a) The tax attributable to amounts deemed distributed under section 
666 is imposed on the beneficiary for the taxable year of the 
beneficiary in which the accumulation distribution is made unless the 
taxable year of the beneficiary is different from that of the trust (see 
section 662(c) and the regulations thereunder). In the case of a trust 
(other than a foreign trust created by a U.S. person), the tax cannot be 
greater than the aggregate of the taxes attributable to those amounts 
had they been included, in accordance with the provisions of section 662 
(a)(2) and (b), in the gross income of the beneficiary for the preceding 
taxable year or years in which they were deemed distributed. In the case 
of a foreign trust created by a U.S. person, the tax on the beneficiary 
shall be computed in accordance with the provisions of section 669 and 
the regulations thereunder. The tax liability of the beneficiary of a 
trust (other than a foreign trust created by a U.S. person), including 
the portion of an entire foreign trust which does not constitute a 
foreign trust created by a U.S. person (see Sec. 1.643(d)-1), for the 
taxable year is computed in the following manner:
    (1) First, compute the amount of tax for the taxable year 
attributable to the section 666 amounts which are included in the gross 
income of the beneficiary for the year. The tax attributable to those 
amounts is the difference between the tax for the taxable year computed 
with the inclusion of the section 666 amounts in gross income and the 
tax computed without including them in gross income.
    (2) Next, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years as if they had been included in 
gross income for those years. The tax attributable to such amounts in 
each such preceding taxable year is the difference between the tax for 
such preceding year computed with the inclusion of the section 666 
amounts in gross income and the tax for such year computed without 
including them in gross income. The tax computation for each preceding 
year shall reflect the taxpayer's marital and dependency status for that 
year.
    (3) The total tax for the taxable year is the tax for that year 
computed without including the section 666 amounts, plus:
    (i) The amount of the tax for the taxable year attributable to the 
section 666 amounts (computed in accordance with subparagraph (1) of 
this paragraph), or (ii) The sum of the taxes for the preceding taxable 
years attributable to the section 666 amounts (computed in accordance 
with subparagraph (2) of this paragraph),

whichever is the smaller.
    (b) The provisions of paragraph (a) of this section may be 
illustrated by the following example:

    Example. (1) During the taxable year 1956, $10,000 is deemed 
distributed under section 666 to a beneficiary, of which $6,000 is 
deemed distributed by the trust on the last day of 1955 and $4,000 on 
the last day of 1954. The beneficiary had taxable income (after 
deductions) from other sources of $5,000 for 1956, $10,000 for 1955, and 
$10,000 for 1954. The beneficiary's tax liability for 1956 is $4,730 
determined as follows:

                                Year 1956                               
                                                                        
Tax on $15,000 (taxable income including section 666 amounts)     $4,730
Tax on $5,000 (taxable income excluding section 666 amounts).      1,100
                                                   ------------         
    Tax attributable to section 666 amounts..................      3,630
                                                   ============         
                                Year 1955                               
                                                                        
Tax on $16,000 (taxable income including section 666 amounts)     $5,200
Tax on $10,000 (taxable income excluding section 666 amounts)      2,640
                                                   ------------         
    Tax attributable to section 666 amounts..................      2,560
                                                   ============         
                                Year 1954                               
                                                                        
Tax on $14,000 (taxable income including section 666 amounts)     $4,260

[[Page 217]]

                                                                        
Tax on $10,000 (taxable income excluding section 666 amounts)      2,640
                                                   ------------         
    Tax attributable to section 666 amounts..................      1,620
                                                   ============         
                                                                        

    (2) Inasmuch as the tax of $3,630 attributable to the section 666 
amounts as computed at 1956 rates is less than the aggregate of the 
taxes of $4,180 ($2,560 plus $1,620) determined for the preceding 
taxable years the amount of $3,630 is added to the tax ($1,100) computed 
for 1956 without including the section 666 amounts.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
737, Jan. 17, 1969]



Sec. 1.668(b)-1  Credit for taxes paid by the trust.

    (a) The taxes imposed on a complex trust for a taxable year which 
would not have been payable by the trust if amounts deemed under section 
666 to have been distributed in the year had in fact been distributed in 
the year are not allowable as a refund to the trust but are allowable as 
a credit against the tax of the beneficiaries to whom the amounts 
described in section 666(a) are distributed.
    (b) The credit to which a beneficiary is entitled under section 
668(b) is allowed for the taxable year in which the accumulation 
distribution (to which the credit relates) is required to be included in 
the gross income of the beneficiary. Any excess over the total tax 
liability of the beneficiary is treated as an overpayment of tax by the 
beneficiary.
    (c) The beneficiary is entitled to a portion of the credit described 
in paragraph (a) of this section in the ratio which the amount of the 
accumulation distribution to him bears to the accumulation distributions 
to all the beneficiaries.



Sec. 1.668(b)-2  Illustration of the provisions of subpart D.

    The provisions of subpart D (section 665 and following), part I, 
subchapter J, chapter 1 of the Code, other than provisions relating to a 
foreign trust created by a U.S. person, may be illustrated by the 
following example:

    Example. (a) Facts. (1) Under the terms of a trust instrument, one-
half of the trust income is required to be distributed currently to 
beneficiary A. The trustee may in his discretion accumulate the balance 
of the income of the trust or he may make distributions to B out of 
income or corpus. The trust is to terminate upon the death of A and the 
corpus is to be distributed to B. Capital gains are allocable to corpus. 
All of the expenses of the trust are charges against income. The trust 
instrument provides for a reserve for depreciation, so that depreciation 
is deductible in computing distributable net income. The trust and both 
beneficiaries report on the calendar year basis. The trust had long-term 
capital gains of $20,000 for 1954, and $10,000 for 1955, which were 
allocated to corpus. The distributable net income of the trust as 
determined under section 643(a) for 1954, 1955, 1956, and 1957 is deemed 
to consist of the following items of income:

----------------------------------------------------------------------------------------------------------------
                                                                                   Interest   Interest          
                                                             Dividends    Rents   (taxable)   (exempt)    Total 
----------------------------------------------------------------------------------------------------------------
1954.......................................................    $15,000   $20,000    $10,000     $5,000   $50,000
1955.......................................................     10,000    15,000     10,000      5,000    40,000
1956.......................................................     10,000    20,000     15,000      5,000    50,000
1957.......................................................     10,000    15,000     15,000      5,000    45,000
----------------------------------------------------------------------------------------------------------------

    (2) One-half ($7,500) of the dividends for 1954 was received by the 
trust on or before July 31, 1954, and the balance was received after 
that date.
    (3) The following distributions were made by the trustee to A and B 
during the taxable years 1954 through 1957:

------------------------------------------------------------------------
                                                 A               B      
------------------------------------------------------------------------
1954....................................    $25,000            None     
1955....................................     20,000            None     
1956....................................     25,000         $45,000     
1957....................................     22,500          29,550     
------------------------------------------------------------------------

    (b) Distributions to A. A is deemed to have received one-half of 
each item of income entering into the computation of distributable net 
income as shown in paragraph (a)(1) of this example. See Sec. 1.662(a)-2 
for rules for the treatment of currently distributable income in the 
hands of the beneficiary.
    (c) Tax liability of the trust--(1) 1954. (i) The tax liability of 
the trust for the taxable year 1954 is $13,451, computed as follows:

Distributable net income under section 643(a) (paragraph                
 (a)(1) of this example).....................................    $50,000
Less amounts not includible in gross income:                            
  Tax-exempt interest.............................     $5,000           
  Dividend exclusion..............................         50           
                                                   -----------          
                                                                   5,050
                                                   ------------         
    Distributable net income as adjusted.....................     44,950
Add: Capital gains (long-term)...............................     20,000
                                                   ------------         
    Total....................................................     64,950
Deductions:                                                             
  Distributions to A..............................    $22,475           
  Capital gain deduction..........................    $10,000           
  Personal exemption..............................        100           
                                                   -----------          

[[Page 218]]

                                                                        
                                                                  32,575
                                                   ------------         
    Taxable income...........................................     32,375
Alternative tax..............................................     13,601
Dividend received credit.....................................        150
                                                   ------------         
    Tax liability............................................     13,451
                                                                        

    (ii) See paragraph (b) of this example for character of income 
deemed distributed to A and section 661 for rules for computing the 
amount deductible by a trust for distributions to beneficiaries. 
Inasmuch as one-half of the dividends of the trust is deemed to be 
distributed to A, $25 of such distribution is deemed to be made from the 
dividend exclusion of $50, and the balance from dividends included in 
the gross income of the trust (that is, since the year 1954 is involved, 
$3,725 from dividends received on or before July 31, 1954, and $3,750 
from dividends received after July 31, 1954). The trust is entitled to a 
dividend received credit attributable to the dividends of $3,750 
received after July 31, 1954, which were not distributed to any 
beneficiary during the taxable year.
    (2) 1955. (i) The tax liability of the trust for the taxable year 
1955 is $8,189, computed as follows:

Distributable net income under section 643(a) (paragraph                
 (a)(1) of this example).....................................    $40,000
Less amounts not includible in gross income:                            
  Tax-exempt interest.............................     $5,000           
  Dividend exclusion..............................         50           
                                                   -----------          
                                                                   5,050
                                                   ------------         
    Distributable net income as adjusted.....................     34,950
Add: Capital gains (long-term)...............................     10,000
                                                   ------------         
    Total....................................................     44,950
Deductions:                                                             
  Distributions to A..............................    $17,475           
  Capital gain deduction..........................      5,000           
  Personal exemption..............................        100           
                                                   -----------          
                                                                  22,575
                                                   ------------         
    Taxable income...........................................     22,375
Alternative tax..............................................      8,388
Dividend received credit.....................................        199
                                                   ------------         
    Tax liability............................................      8,189
                                                                        

    (ii) See paragraph (b) of this example for character of income 
deemed distributed to A and section 661 for rules for computing the 
amount deductible by a trust for distributions to beneficiaries. 
Inasmuch as one-half ($4,975) of the dividends of $9,950 ($10,000 less 
dividend exclusion of $50) included in the gross income of the trust is 
deemed distributed to A, the trust is entitled to a dividend received 
credit with respect to the dividends of $4,975 which were not 
distributed to any beneficiary during the taxable year.
    (3) 1956 and 1957. The trust had no tax liability for the taxable 
years 1956 and 1957 since all of its income was distributed during such 
years.
    (d) Accumulation distributions. (1) Accumulation distributions of 
$20,000 and $7,050, as defined in section 665(b), were made to B during 
the years 1956 and 1957, respectively, computed as shown below:

------------------------------------------------------------------------
                                                       1956       1957  
------------------------------------------------------------------------
Distributable net income of the trust as computed                       
 under section 643(a).............................    $50,000    $45,000
Less. Income currently distributable to A.........     25,000     22,500
                                                   ---------------------
    Balance of income.............................     25,000     22,500
Other amounts distributed to B....................     45,000     29,550
                                                   ---------------------
    Accumulation distributions to B...............     20,000      7,050
------------------------------------------------------------------------

    (2) B is deemed to have received one-half of each item of income 
entering into the computation of distributable net income (shown in 
paragraph (a)(1) of this example) for the years 1956 and 1957.
    (3) The accumulation distribution for 1956 must first be allocated 
to the preceding taxable years as provided in section 666. After the 
application of the provisions of subpart D to the 1956 accumulation 
distribution and to the undistributed net incomes of the preceding 
taxable years, a similar allocation must be made of the 1957 
accumulation distribution.
    (e) Throwback of 1956 accumulation distribution to 1955. The 
accumulation distribution of $20,000 for 1956 must be allocated to the 
first preceding taxable year 1955, before allocation is made to the 
second preceding taxable year 1954.
    (1) 1955 Undistributed net income. (i) The undistributed net income 
of the trust for 1955, determined as of the close of 1955, is $12,885, 
computed as follows:

  Distributable net income as computed under section 643(a)             
              (paragraph (a)(1) of this example)                 $40,000
Less:                                                                   
  Distributions to A..............................    $20,000           
  Taxes imposed on the trust......................      7,115           
                                                   -----------          
                                                       27,115           
                                                   ------------         
    Undistributed net income as of the close of                         
     1955.........................................     12,885           
                                                                        

    (ii) The taxes imposed on the trust of $7,115 are that portion of 
the taxes paid by the trust for 1955 which is attributable to the 
undistributed portion of distributable net income included in the 
taxable income of the trust (the ``balance'' in the computation below) 
and is determined as follows:

Taxable income (paragraph (c)(2)(i) of this example..........    $22,375
Capital gains allocable to corpus.................    $10,000           
Less:                                                                   
  Capital gain deduction...............     $5,000                      
  Personal exemption...................        100                      
                                        -----------                     

[[Page 219]]

                                                                        
                                                        5,100           
                                        -----------                     
Portion of taxable income allocable to corpus................      4,900
                                        ------------                    
    Balance..................................................     17,475
                                        ============                    
Total taxes paid by the trust................................      8,189
Taxes on income ($4,900) allocable to corpus.................      1,074
                                        ------------                    
    Taxes imposed on the trust (section 665(c))..............      7,115
                                                                        

    (iii) The amount of $1,074 is the taxes which the trust would have 
paid for 1955 had all of the distributable net income been distributed 
during the year.
    (2) Allocation of 1956 accumulation distribution to the preceding 
taxable year 1955. The portion of the 1956 accumulation distribution 
which is deemed under section 666(a) to be distributed to B on the last 
day of 1955 (the first preceding taxable year) is $12,885, an amount 
equal to the undistributed net income for 1955. An additional amount 
equal to the taxes imposed on the trust ($7,115) is, under section 
666(b), also deemed to be distributed to B on the last day of 1955. 
Thus, a total of $20,000 ($12,885 plus $7,115) is deemed to be 
distributed to B on December 31, 1955, by reason of the allocation of 
the 1956 accumulation distribution to the first preceding taxable year. 
See paragraph (h) of this example for the treatment of the amount of 
$20,000 in the hands of B.
    (3) Character of amounts deemed distributed. Inasmuch as one-half of 
the 1955 distributable net income of the trust as determined under 
section 643(a) was currently distributable to A and the balance of such 
income is deemed under section 666 to be distributed to B on December 
31, 1955, the distribution to B is deemed to consist of one-half of each 
item of income entering into the computation of the 1955 distributable 
net income; that is, dividends of $5,000, rents of $7,500, taxable 
interest of $5,000, and tax-exempt interest of $2,500.
    (4) Credit for taxes paid by the trust. The amount of the taxes for 
the year 1955 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B for 
1956 under section 668(b) is $7,115. See also paragraph (h)(3) of this 
example.
    (5) Effect of application of provisions of subpart D to the year 
1955. After the allocation of the 1956 accumulation distribution to the 
preceding taxable year 1955, the undistributed portion of the 
distributable net income, the undistributed net income, and the taxes 
imposed on the trust for 1955 are zero. The portion of the 1956 
accumulation distribution which is unabsorbed by the 1955 undistributed 
net income is $7,115, determined as follows:

1956 accumulation distribution (paragraph (d)(1) of this                
 example)....................................................    $20,000
Less: Amount allocable to 1955...............................     12,885
                                                   ------------         
    Balance allocable to second preceding taxable year 1954..      7,115
                                                                        

    (f) Throwback of 1956 accumulation distribution to 1954. The 
unabsorbed portion of the 1956 accumulation distribution of $7,115 is 
allocable to the second preceding taxable year 1954 and is treated under 
section 666 as a distribution to B on the last day of such year.
    (1) 1954 Undistributed net income. (i) The undistributed net income 
of the trust for 1954, determined as of the close of 1954, is $14,155, 
computed as follows:

Distributable net income as computed under section 643(a)               
 (paragraph (a)(1) of this example)..........................    $50,000
Less:                                                                   
  Distributions to A..............................    $25,000           
  Taxes imposed on the trust......................     10,845           
                                                   -----------          
                                                                  35,845
                                                   ------------         
    Undistributed net income as of the close of 1954.........     14,155
                                                                        

    (ii) The taxes imposed on the trust of $10,845 are that portion of 
the taxes paid by the trust for 1954 which is attributable to the 
undistributed portion of distributable net income included in the 
taxable income of the trust (the ``balance'' in the computation below in 
this subdivision) and is determined as follows:

Taxable income (paragraph (c)(1)(i) of this example).........    $32,375
Capital gains allocable to corpus.................    $20,000           
Less:                                                                   
  Capital gain deduction...............    $10,000                      
  Personal exemption...................        100                      
                                        -----------                     
                                                       10,100           
                                        -----------                     
    Portion of taxable income allocable to corpus............      9,900
                                        ------------                    
    Balance..................................................     22,475
                                        ============                    
Total taxes paid by the trust................................     13,451
Taxes on income ($9,900) allocable to corpus.................      2,606
                                        ------------                    
    Taxes imposed on the trust (section 665(c) ).............     10,845
                                                                        

    (iii) The amount of $2,606 is the taxes which the trust would have 
paid for 1954 had all of the distributable net income been distributed 
during that year.
    (2) Allocation of 1956 accumulation distribution to the second 
preceding taxable year 1954. Since the unabsorbed portion of the 1956 
accumulation distribution of $7,115 is less than the 1954 undistributed 
net income of $14,155, the trust is deemed under section 666(c) to have 
also distributed an additional amount ($5,451) equal to a pro rata 
portion (7,115/14,155 x $10,845) of the taxes imposed on the trust for 
1954. Thus, a total of $12,566 ($7,115 plus $5,451) is deemed to be 
distributed to B on December 31, 1954, by reason of the throwback of the 
1956 accumulation distribution. See paragraph (h) of this example for 
the treatment of the amount of $12,566 in the hands of B.

[[Page 220]]

    (3) Character of amounts deemed distributed to B. The amount of 
$12,566 which, under section 666, is deemed to be distributed to B on 
December 31, 1954, is deemed to be composed of the following items of 
income of the trust: Dividends, $3,770 (15,000/50,000 x $12,566); rents, 
$5,026 (20,000/50,000 x $12,566); taxable interest, $2,513 (10,000/
50,000 x $12,566); and tax-exempt interest, $1,257 (5,000/
50,000 x $12,566). One-half of the dividends of $3,770 is considered as 
distributed from the dividends received by the trust on or before July 
31, 1954, of which $13 (3,770/15,000 x $50) is deemed distributed from 
the dividends excluded under section 116, and the other half as 
distributed from the dividends received after July 31, 1954. Thus, of 
the total of $12,566 deemed distributed to B, $11,296 is considered as 
made from income included in the gross income of the trust and $1,270 
from non-taxable income of the trust.
    (4) Credit for taxes paid by the trust. The amount of the taxes for 
the year 1954 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B for 
1956 under section 668(b), because of the allocation of the 1956 
accumulation distribution to 1954, is $5,401, computed as follows:

Taxable income of the trust as of the close of 1954                     
 (paragraph (c)(1) of this example)..........................    $32,375
Less: Amount deemed distributed to B under section 666 from             
 the taxable income of the trust.............................     11,296
                                                   ------------         
    Taxable income adjusted as of the close of 1956..........     21,079
                                                   ------------         
(Taxes on $21,079 (alternative tax)..........................     $8,050
Taxes on income allocable to corpus (subparagraph (1)(ii) of            
 this paragraph).............................................     $2,606
                                                   ------------         
    Taxes imposed on the trust determined as of the close of            
     1956....................................................      5,444
                                                   ============         
Taxes imposed on the trust determined as of the close of 1954    $10,845
Taxes imposed on the trust determined as of the close of 1956      5,444
                                                   ------------         
    Amount of taxes allowed as a credit to B under section              
     668(b)..................................................      5,401
                                                                        

    (5) Effect of application of provisions of subpart D to the year 
1954. (i) The undistributed portion of the distributable net income of 
the trust for the year 1954, determined as of the close of 1956, is 
$12,434, computed as follows:

Distributable net income (section 643(a))....................    $50,000
Less:                                                                   
  Amount currently distributable to A.............    $25,000           
  Amount deemed distributed to B under section 666     12,566           
                                                     --------     37,566
                                                   ------------         
    Undistributed portion of distributable net income as of             
     the close of 1956.......................................     12,434
                                                                        

    (ii) The amount of $12,434 is deemed to consist of dividends of 
$3,730, rents of $4,974, taxable interest of $2,487, and tax-exempt 
interest of $1,243, determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                                          Interest      Interest                
                                               Dividends      Rents       (taxable)     (exempt)        Total   
----------------------------------------------------------------------------------------------------------------
Trust income...............................    $15,000      $20,000       $10,000        $5,000     \1\$50,000  
                                            ====================================================================
Distributions:                                                                                                  
  To A.....................................      7,500       10,000         5,000         2,500     \2\25,000   
  To B.....................................      3,770        5,026         2,513         1,257     \3\12,566   
                                            ====================================================================
    Total..................................     11,270       15,026         7,513         3,757        37,566   
                                            ====================================================================
Balance....................................      3,730        4,974         2,487         1,243        12,434   
----------------------------------------------------------------------------------------------------------------
\1\See paragraph (a)(1) of this example.                                                                        
\2\See paragraph (b) of this example.                                                                           
\3\See paragraph (f)(3) of this example.                                                                        

    (iii) The undistributed net income of the trust for 1954, determined 
as of the close of 1956, is $6,990, computed as follows:

Undistributed portion of distributable net income as of the             
 close of 1956..............................................     $12,434
Less: Taxes imposed on the trust determined as of the close             
 of 1956 (subparagraph (4) of this paragraph)...............       5,444
                                                             -----------
  Undistributed net income as of the close of 1956..........       6,990
                                                                        

    (g) Throwback of 1957 accumulation distribution. Inasmuch as all of 
the income of the trust for the first preceding taxable year 1956 was 
distributed during such year and the trust had no undistributed net 
income for the second preceding taxable year 1955 after the application 
of subpart D to the accumulation distribution made during 1956, the 1957 
accumulation distribution of $7,050 is allocable to the third preceding 
taxable year 1954. See paragraph (d)(1) of this example for computation 
of the accumulation distribution.

[[Page 221]]

    (1) Allocation of 1957 accumulation distribution to the preceding 
taxable year 1954. The portion of the 1957 accumulation distribution 
which is deemed under section 666(a) to be distributed to B on the last 
day of 1954 is $6,990, an amount equal to the undistributed net income 
of the trust for 1954, determined as of the close of 1956. An additional 
amount equal to the taxes imposed on the trust ($5,444), determined as 
of the close of 1956, is under section 666(b) also deemed to be 
distributed to B on the last day of 1954. See paragraph (f) (4) and (5) 
of this example. Thus, a total of $12,434 ($6,990 plus $5,444) is deemed 
to be distributed to B on December 31, 1954, by reason of the allocation 
of the 1957 accumulation distribution to the taxable year 1954. See 
paragraph (j) of this example for the treatment of the amount of $12,434 
in the hands of B.
    (2) Character of amounts deemed distributed. Inasmuch as the balance 
of the 1954 distributable net income of the trust is deemed under 
section 666 to be distributed to B on December 31, 1954, the 
distribution is deemed to consist of dividends of $3,730, rents of 
$4,974, taxable interest of $2,487, and tax-exempt interest of $1,243. 
See paragraph (f)(5)(ii) of this example.
    (3) Credit for taxes paid by the trust. The amount of taxes for the 
year 1954 which may not be refunded or credited to the trust under 
section 667 and which is allowed as a credit against the tax of B under 
section 668(b) is $5,444, the amount of taxes imposed on the trust 
determined as of the close of 1956. See paragraph (f)(4) of this 
example.
    (4) Effect of application of provisions of subpart D to the year 
1954. After the allocation of the 1957 accumulation distribution to the 
preceding taxable year 1954, the undistributed portion of the 
distributable net income, the undistributed net income, and the taxes 
imposed on the trust for 1954 are zero. The balance of $60 ($7,050 less 
$6,990) of the 1957 accumulation distribution remaining after the 
allocation of the accumulation distribution to the year 1954, may not be 
allocated to the year 1953 since that year is not subject to the 
provisions of the Internal Revenue Code of 1954.
    (h) Determination of B's tax liability; taxable year 1956--(1) 
Amount of trust income includible in gross income. (i) Of the amount of 
$45,000 distributed by the trust to B during the taxable year 1956, 
$25,000 is treated as a distribution out of trust income for that year 
within the meaning of section 662(a)(2), and $20,000 as an accumulation 
distribution within the meaning of section 665(b) (see paragraph (d) of 
this example). However, $12,885 plus taxes of $7,115 is deemed 
distributed to B on December 31, 1955, and $7,115 plus taxes of $5,451 
on December 31, 1954, under section 666 by reason of the accumulation 
distribution made during 1956, and these amounts are includible in B's 
gross income for 1956 to the extent that they would have been includible 
in his gross income under section 662 (a)(2) and (b) for 1955 and 1954, 
respectively, had they been distributed on the last day of those years.
    (ii) The amounts distributed to B out of trust income for the year 
1956, and the amounts deemed distributed out of income for the preceding 
taxable years 1955 and 1954 have the following character for the purpose 
of determining the amount includible in B's gross income for 1956:

----------------------------------------------------------------------------------------------------------------
                                                                                  Interest   Interest           
                           Year                             Dividends    Rents   (taxable)   (exempt)    Total  
----------------------------------------------------------------------------------------------------------------
1956......................................................     $5,000   $10,000     $7,500     $2,500  \1\ $25,0
                                                                                                              00
1955......................................................      5,000     7,500      5,000      2,500  \2\ 20,00
                                                                                                               0
1954......................................................      3,770     5,026      2,513      1,257  \3\ 12,56
                                                                                                               6
                                                           -----------------------------------------------------
 Total....................................................     13,770    22,526     15,013      6,257    57,566 
----------------------------------------------------------------------------------------------------------------
\1\ See paragraph (d)(2) of this example.                                                                       
\2\ See paragraph (e)(3) of this example.                                                                       
\3\ See paragraph (f)(3) of this example.                                                                       

Thus, B will include in gross income for 1956 dividends of $13,770 
(subject to the dividend exclusion), rents of $22,526, and taxable 
interest of $15,013, and will exclude the tax-exempt interest of $6,257.
    (2) Computation of tax. (i) For the purpose of computing B's tax 
liability, it is assumed that he was single during the taxable years 
1954, 1955, and 1956, and that his taxable income (derived from salary) 
for each of the years 1954 and 1955 amounted to $13,400 on which a tax 
of $4,002 was paid for each year. It is also assumed that his income 
(other than distributions from the trust) for 1956 was $15,000 derived 
from salary, and he had allowable deductions of $10,600, which included 
the deduction for personal exemption.
    (ii) The computation of the tax for the taxable year 1956 
attributable to the section 666 amounts which are included in B's gross 
income for such year, as provided in paragraph (a)(1) of Sec. 1.668(a)-
4, is as follows:

------------------------------------------------------------------------
                                                      (1)         (2)   
                                                    Section     Section 
                                                      666         666   
                                                    amounts     amounts 
                                                   excluded    included 
------------------------------------------------------------------------
Salary..........................................     $15,000     $15,000

[[Page 222]]

                                                                        
Income from trust:                                                      
  Dividends ($50 excluded)......................       4,950      13,720
  Rents.........................................      10,000      22,526
  Taxable interest..............................       7,500      15,013
                                                 -----------------------
    Total.......................................      37,450      66,259
Less: Allowable deductions......................      10,600      10,600
                                                 -----------------------
    Taxable income..............................      26,850      55,659
                                                 =======================
Total tax.......................................      11,267      31,064
Less: Dividend received credit..................         198         475
                                                 -----------------------
    Tax liability...............................     $11,069      30,589
Tax on income from which section 666 amounts are                        
 excluded.......................................  ..........      11,069
                                                 -----------------------
    1956 tax attributable to section 666 amounts  ..........      19,520
------------------------------------------------------------------------

Only that portion of the dividends received by the trust after July 31, 
1954, and deemed distributed to B under section 666, on the last day of 
such year is included in computing the dividend received credit shown in 
column (2). See paragraph (f)(3) of this example.
    (iii) The computation of the taxes for the preceding taxable years 
attributable to the section 666 amounts which are deemed distributed by 
the trust on the last day of these years, as provided in paragraph 
(a)(2) of Sec. 1.668(a)-4, is as follows:

------------------------------------------------------------------------
                                                     Preceding taxable  
                                                           years        
                                                 -----------------------
                                                                Second  
                                                  First 1955     1954   
------------------------------------------------------------------------
Taxable income previously reported..............     $13,400     $13,400
Section 666 amounts:                                                    
  Dividends ($50 excluded)......................       4,950       3,720
  Rents.........................................       7,500       5,026
  Taxable interest..............................       5,000       2,513
                                                 -----------------------
    Taxable income as adjusted..................      30,850      24,659
                                                 =======================
Total tax.......................................      13,747       9,949
Less: Dividend received credit..................         198          75
                                                 -----------------------
    Balance of tax..............................      13,549       9,874
Tax liability...................................       4,002       4,002
                                                 -----------------------
    Tax attributable to section 666 amounts.....       9,547       5,872
------------------------------------------------------------------------

Only that portion ($1,885) of the dividends received by the trust after 
July 31, 1954, and deemed distributed under section 666 on the last day 
of that year, is included in computing the dividend received credit of 
$75 for the year 1954. See paragraph (f)(3) of this example.
    (iv) Inasmuch as the aggregate of the taxes of $15,419 ($9,547 plus 
$5,872) attributable to the section 666 amounts as determined for the 
preceding taxable years is less than the tax of $19,520 determined for 
the taxable year 1956, the amount of $15,419 shall be added to the tax 
computed for 1956 without including the section 666 amounts. Thus, B's 
tax liability for 1956 is $26,488 ($11,069 plus $15,419).
    (3) Credits against the tax. B is allowed under section 668(b) a 
credit of $12,516 ($5,401 for 1954 and $7,115 for 1955) against his 1956 
tax liability for the taxes paid by the trust for the preceding taxable 
years and which may not be refunded or credited to the trust under 
section 667. See paragraphs (e)(4) and (f)(4) of this example.
    (i) [Reserved]
    (j) Taxable year 1957--(1) Amount of trust income includible in 
gross income. (i) Of the amount of $29,550 distributed by the trust to B 
during the taxable year 1957, $22,500 is treated as a distribution out 
of trust income for that year within the meaning of section 662(a)(2), 
and $7,050 as an accumulation distribution within the meaning of section 
665(b) (see paragraph (d) of this example). However, $6,990 plus taxes 
of $5,444 is deemed distributed to B on December 31, 1954, under section 
666 by reason of the accumulation distribution made during 1957, and 
that amount is includible in B's gross income for 1957, to the extent 
that it would have been includible in his gross income under section 662 
(a)(2) and (b) for 1954, had it been distributed on the last day of that 
year.
    (ii) The amounts deemed distributed to B out of trust income for the 
year 1957 and the preceding taxable year 1954 are deemed to have the 
following character for the purpose of determining the amount includible 
in B's gross income for 1957:

----------------------------------------------------------------------------------------------------------------
                                                                                   Interest  Interest           
                            Year                              Dividends   Rents   (taxable)  (exempt)    Total  
----------------------------------------------------------------------------------------------------------------
1957........................................................    $5,000    $7,500     $7,500    $2,500  \1\$22,50
                                                                                                               0
1954........................................................     3,730     4,974      2,487     1,243  \2\12,434
                                                             ---------------------------------------------------
    Total...................................................     8,730    12,474      9,987     3,743    34,934 
----------------------------------------------------------------------------------------------------------------
\1\See paragraph (d)(2) of this example.                                                                        
\2\See paragraph (g)(2) of this example.                                                                        


[[Page 223]]

Thus, B will include in gross income for the year 1957 dividends of 
$8,730 (subject to the dividend exclusion), rents of $12,474, and 
taxable interest of $9,987 and will exclude the tax-exempt interest of 
$3,743.
    (2) Computation of tax. (i) For the purpose of computing B's tax 
liability for 1957, it is assumed that he was single for the entire year 
and had income (other than distributions from the trust) of $15,000 from 
salary. Also, he had allowable deductions of $8,100, which included the 
deductions for personal exemption.
    (ii) The computation of the tax for the taxable year 1957 
attributable to the section 666 amounts which are included in B's gross 
income for that year, as provided in paragraph (a)(1) of Sec. 1.668(a)-
4, is as follows:

------------------------------------------------------------------------
                                                    Section     Section 
                                                      666         666   
                                                    amounts     amounts 
                                                   excluded    included 
------------------------------------------------------------------------
Salary..........................................     $15,000     $15,000
Trust income:                                                           
  Dividends ($50 excluded)......................       4,950       8,680
  Rents.........................................       7,500      12,474
  Taxable interest..............................       7,500       9,987
                                                 -----------------------
    Total.......................................      34,950      46,141
Less: Allowable deductions                             8,100       8,100
                                                 -----------------------
    Taxable income..............................      26,850      38,041
                                                 =======================
  Total tax.....................................      11,267      18,388
Less: Dividends received credit.................         198         275
                                                 -----------------------
    Tax liability...............................      11,069      18,113
Tax on income from which section 666 amounts are                        
 excluded.......................................  ..........      11,069
                                                 -----------------------
    1957 tax attributable to section 666 amounts  ..........       7,044
------------------------------------------------------------------------

See explanation following computation in paragraph (h)(2)(ii) of this 
example with respect to the computation of the dividend received credit 
on dividends received by the trust in 1954.
    (iii) The amount of tax, computed at 1954 rates, attributable to the 
section 666 amounts which are deemed to have been distributed by the 
trust on the last day of 1954, is $6,939, computed as follows:

1954 taxable income as adjusted (paragraph (h)(2)(iii) of               
 this example)..............................................     $24,659
Section 666 amounts:                                                    
  Dividends.................................................       3,730
  Rents.....................................................       4,974
  Taxable interest..........................................       2,487
                                                 -------------          
    Taxable income as adjusted..............................      35,850
                                                 =============          
Total tax...................................................      16,963
Less: Dividends received credit.............................         150
                                                 -------------          
    Balance of tax..........................................      16,813
Tax liability for 1954..........................      $4,002            
Tax attributable to 1956 accumulation                                   
 distribution this example).....................       5,872            
                                                 ------------           
                                                                   9,874
                                                 -------------          
  Tax attributable to the section 666 amounts distributed in            
   1957.....................................................       6,939
                                                                        

Only that portion ($3,750) of the dividends received by the trust after 
July 31, 1954, and deemed distributed under section 666 on the last day 
of that year, is included in computing the dividend received credit of 
$150. See paragraphs (f)(3) and (g)(2) of this example.
    (iv) Inasmuch as the tax of $6,939 attributable to the section 666 
amounts as determined for the preceding taxable year 1954 is less than 
the tax of $7,044 attributable to these amounts for the year 1957, the 
amount of $6,939 shall be added to the tax computed for 1957 without 
including in gross income the section 666 amounts. Thus, B's tax 
liability for 1957 is $18,008 ($11,069 plus $6,939).
    (3) Credit against the tax. B is allowed under section 668(b) a 
credit of $5,444 against his 1957 tax liability for the balance of the 
taxes paid by the trust for 1954 and which may not be refunded or 
credited to the trust under section 667. See paragraph(g)(3) of this 
example.

(Sec. 669(a) as amended by sec. 331(a), Tax Reform Act 1969 (83 Stat. 
592))

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
738, Jan. 17, 1969]



Sec. 1.669(a)-1A   Amount allocated.

    (a) In general. After a trust has distributed all of its 
undistributed net income, the rules concerning the treatment of capital 
gain distributions (prescribed under section 669) may become applicable 
to an accumulation distribution. This section prescribes rules to 
determine from which years capital gain distributions are considered to 
be made. For the definition of ``capital gain distribution,'' see 
Sec. 1.665(g)-1A. Section 669 does not apply to a trust that has 
distributed all of its income currently since its inception. See 
Sec. 1.668(a)-1A(c). Capital gain retains its character in the hands of 
the beneficiary. See Sec. 1.669(f)-1A. A capital gain distribution to 
more than one beneficiary will be allocated among them. See 
Sec. 16.668(a)-2A.
    (b) First-in, first-out rule. A capital gain distribution is 
allocated to the preceding taxable years of the trust (as defined in 
Sec. 1.665(e)-1A(a)(1)(iii)), according to the undistributed capital 
gain of the trust for such years. For this purpose, a capital gain 
distribution is first allocated to the earliest such preceding taxable 
year in which there is undistributed capital gain and

[[Page 224]]

shall then be allocated in turn, beginning with the next earliest, to 
any remaining preceding taxable years of the trust. The portion of the 
capital gain distribution allocated to the earliest preceding taxable 
year is the amount of undistributed capital gain for that preceding 
taxable year. The portion of the capital gain distribution allocated to 
any preceding taxable year subsequent to the earliest such preceding 
taxable year is the excess of the capital gain distribution over the 
aggregate of the undistributed capital gain for all earlier preceding 
taxable years. See paragraph (c) of this section for adjustments to 
undistributed capital gain for prior distributions.
    (c) Reduction of undistributed capital gain for prior capital gain 
distributions. For the purposes of allocating to any preceding taxable 
year a capital gain distribution of the taxable year, the undistributed 
capital gain of such preceding taxable year is reduced by the amount 
from such year deemed distributed in any capital gain distribution made 
in any taxable year intervening between such preceding taxable year and 
the taxable year. Accordingly, for example, if a trust subject to the 
capital gain throwback has no undistributed net income but has 
undistributed capital gain for 1974, and makes capital gain 
distributions during the taxable years 1978 and 1979, then in 
determining that part of the 1979 capital gain distribution that is 
thrown back to 1974, the undistributed capital gain for 1974 is reduced 
by the amount of such undistributed capital gain for 1974 deemed 
distributed in the 1978 capital gain distribution.
    (d) Rule when no undistributed capital gain. If, before the 
application of the provisions of subpart D to a capital gain 
distribution for the taxable year, there is no undistributed capital 
gain for a preceding taxable year, then no portion of the capital gain 
distribution is deemed distributed on the last day of such preceding 
taxable year. Thus, for example, if a capital gain distribution is made 
during the taxable year 1975 from a trust whose earliest preceding 
taxable year is taxable year 1970, and the trust had no undistributed 
capital gain for 1970, then no portion of the 1975 capital gain 
distribution is deemed distributed on the last day of 1970.
    (e) Example. The provisions of this section may be illustrated by 
the following example:

    Example. In 1977, a trust reporting on the calendar year basis makes 
a capital gain distribution of $33,000. In 1969, the trust had $6,000 of 
undistributed capital gain; in 1970, $4,000; in 1971, none; in 1972, 
$7,000; in 1973, $5,000; in 1974, $8,000; in 1975, $6,000; in 1976, 
$4,000; and $6,000 in 1977. The capital gain distribution is deemed 
distributed $6,000 in 1969, $4,000 in 1970, none in 1971, $7,000 in 
1972, $5,000 in 1973, $8,000 in 1974, and $3,000 in 1975.

[T.D. 7204, 37 FR 17153, Aug. 25, 1972]



Sec. 1.669(b)-1A   Tax on distribution.

    (a) In general. The partial tax imposed on the beneficiary by 
section 668(a)(3) shall be the lesser of:
    (1) The tax computed under paragraph (b) of this section (the 
``exact'' method), or
    (2) The tax computed under paragraph (c) of this section (the 
``short-cut'' method),

except as provided in Sec. 1.669(c)-3A (relating to failure to furnish 
proper information) and paragraph (d) of this section (relating to 
disallowance of short-cut method). For purposes of this paragraph, the 
method used in the return shall be accepted as the method that produces 
the lesser tax. The beneficiary's choice of the two methods is not 
dependent upon the method that he uses to compute his partial tax 
imposed by section 668(a)(2).
    (b) Computation of partial tax by the exact method. The partial tax 
referred to in paragraph (a)(1) of this section is computed as follows:
    (1) First, compute the tax attributable to the section 669 amounts 
for each of the preceding taxable years. For purposes of this paragraph, 
the ``section 669 amounts'' for a preceding taxable year are the amounts 
deemed distributed under section 669(a) on the last day of such 
preceding taxable year, plus the amount of taxes deemed distributed on 
such day under section 669 (d) or (e). The tax attributable to such 
amounts in each prior taxable year of the beneficiary is the difference 
between the tax for such year computed with the inclusion of the section 
669

[[Page 225]]

amounts in the beneficiary's gross income and the tax for such year 
computed with the inclusion of them in such gross income. Tax 
computations for each such year shall reflect a taxpayer's marital, 
dependency, exemption, and filing status for such year. To the extent 
the undistributed capital gain of a trust deemed distributed in a 
capital gain distribution includes amounts received as a capital gain 
distribution from another trust, for purposes of this paragraph they 
shall be considered as amounts deemed distributed by the trust under 
section 669(a) on the last day of each of the preceding taxable years in 
which such amounts were accumulated by such other trust. For example, 
assume trust Z, a calendar year trust received in its taxable year 1975 
a capital gain distribution from trust Y, a calendar year trust, that 
included undistributed capital gain of trust Y for the taxable years 
1972, 1973, and 1974. To the extent a capital gain distribution made by 
trust Z in its taxable year 1976 includes such undistributed capital 
gain, it shall be considered a capital gain distribution by trust Z in 
the taxable year 1976 and under section 669(a) will be deemed 
distributed on the last day of the preceding taxable years 1972, 1973, 
and 1974.
    (2) From the sum of the taxes for the prior taxable years 
attributable to the section 669(a) amounts (computed in accordance with 
subparagraph (1) of this paragraph), subtract so much of the amount of 
taxes deemed distributed to the beneficiary under Secs. 1.669(d)-1A and 
1.669(e)-1A as does not exceed such sum. The resulting amount, if any, 
is the partial tax on the beneficiary, computed under the exact method, 
for the taxable year in which the capital gain distribution is paid, 
credited, or required to be distributed to the beneficiary.
    (c) Computation of tax by the short-cut method. (1) The tax referred 
to in paragraph (a)(2) of this section is computed as follows:
    (i) First, determine the number of preceding taxable years of the 
trust on the last day of which an amount is deemed under section 669(a) 
to have been distributed. For purposes of the preceding sentence, the 
preceding taxable years of a trust that has received a capital gain 
distribution from another trust shall include the taxable years of such 
other trust in which an amount was deemed distributed in such capital 
gain distribution. For example, assume trust Z, a calendar year trust, 
received in its taxable year 1975 a capital gain distribution from trust 
Y, a calendar year trust, that included undistributed capital gain of 
trust Y for the taxable years 1972, 1973, and 1974. To the extent a 
capital gain distribution made by trust Z in its taxable year 1976 
includes such undistributed capital gain, it shall be considered a 
capital gain distribution by trust Z in the taxable year 1976 and under 
section 669(a) will be deemed distributed on the last day of the 
preceding taxable years 1972, 1973, and 1974. For purposes of this 
subparagraph, such number of preceding taxable years of the trust shall 
not include any preceding taxable year of the trust in which the 
undistributed capital gain deemed distributed is less than 25 percent of 
(a) the total amounts deemed under section 669(a) to be undistributed 
capital gain from preceding taxable years, divided by (b) the number of 
such preceding taxable years of the trust on the last day of which an 
amount is deemed under section 669(a) to have been distributed without 
application of this sentence. For example, assume that a capital gain 
distribution of $90,000 made to a beneficiary in 1979 is deemed 
distributed in the amounts of $29,000 in each of the years 1972, 1973, 
and 1974, and $3,000 in 1975. The number of preceding taxable years on 
the last day of which an amount was deemed distributed without reference 
to the second sentence of this subparagraph is 4. However, the 
distribution deemed made in 1975 ($3,000) is less than $5,625, which is 
25 percent of (a) the total undistributed capital gain deemed 
distributed under section 669(a) ($90,000) divided by (b) the number of 
such preceding taxable years (4), or $22,500. Therefore, for purposes of 
this subparagraph, the capital gain distribution is deemed distributed 
in only 3 preceding taxable years (1972, 1973, and 1974).
    (ii) Second, divide the amount (representing the capital gain 
distribution and taxes deemed distributed) required under section 668(a) 
to be included in the income of the beneficiary for the

[[Page 226]]

taxable year by the number of preceding taxable years of the trust on 
the last day of which an amount is deemed under section 669(a) to have 
been distributed (determined as provided in subdivision (i) of this 
paragraph). The amount determined under this subdivision, including 
taxes deemed distributed, consists of the same proportion of long-term 
and short-term capital gain as the total of each type of capital gain 
deemed distributed in the capital gain distribution bears to the total 
undistributed capital gain from such preceding taxable years deemed 
distributed in the capital gain distribution. For example, assume that 
an amount of $50,000 is deemed distributed under section 669(a) from 
undistributed capital gain of 5 preceding taxable years of the trust, 
and consists of $30,000 of long-term capital gain and $20,000 of short-
term capital gain. Taxes attributable to such amounts in the amount of 
$10,000 are also deemed distributed. The amount determined under this 
subdivision, $12,000 ($50,000 income plus $10,000 tax, divided by 5 
years), is deemed to consist of $7,200 of long-term capital gain and 
$4,800 in short-term capital gain.
    (iii) Third, compute the tax of the beneficiary for each of the 3 
taxable years immediately preceding the year in which the capital gain 
distribution is paid, credited, or required to be distributed to him,
    (a) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subdivision (ii) of this 
subparagraph, and
    (b) Without such inclusion.

The difference between the amount of tax computed under (a) of this 
subdivision for each year and the amount computed under (b) of this 
subdivision for that year is the additional tax resulting from the 
inclusion in gross income for that year of the amount determined under 
subdivision (ii) of this subparagraph.
    (iv) Fourth, add the additional taxes resulting from the application 
of subdivision (iii) of this subparagraph and then divide this amount by 
3.
    (v) Fifth, the resulting amount is then multiplied by the number of 
preceding taxable years of the trust on the last day of which an amount 
is deemed under section 669(a) to have been distributed (previously 
determined under subdivision (i) of this subparagraph).
    (vi) The resulting amount, less so much of the amount of taxes 
deemed distributed to the beneficiary under Secs. 1.669(d)-1A and 
1.669(e)-1A as does not exceed such resulting amount, is the tax under 
the short-cut method provided in section 669(b)(1)(B).
    (2) See Sec. 1.668(b)-1A(c) for examples of the short-cut method in 
the context of an accumulation distribution.
    (d) Disallowance of short-cut method. If, in any prior taxable year 
of the beneficiary in which any part of the capital gain distribution is 
deemed to have been distributed under section 669(a) to such 
beneficiary, any part of prior capital gain distributions by each of two 
or more other trusts is deemed under section 669(a) to have been 
distributed to such beneficiary, then the short-cut method under 
paragraph (c) of this section may not be used and the partial tax 
imposed by section 668(a)(3) shall be computed only under the exact 
method under paragraph (b) of this section. For example, assume that, in 
1978, trust X makes a capital gain distribution to A, who is on the 
calendar year basis, and part of the distribution is deemed under 
section 669(a) to have been distributed on March 31, 1974. In 1977, A 
had received a capital gain distribution from both trust Y and trust Z. 
Part of the capital gain distribution from trust Y was deemed under 
section 669(a) to have been distributed to A on June 30, 1974, and part 
of the capital gain distribution from trust Z was deemed under section 
669(a) to have been distributed to A on December 31, 1974. Because there 
were portions of capital gain distributions from two other trusts deemed 
distributed within the same prior taxable year of A (1974), the 1978 
capital gain distribution from trust X may not be computed under the 
short-cut method provided in paragraph (c) of this section. Therefore 
the exact method under paragraph (b) of this section must be used to 
compute the tax imposed by section 668(a)(3).

[T.D. 7204, 37 FR 17153, Aug. 25, 1972]

[[Page 227]]



Sec. 1.669(c)-1A   Special rules applicable to section 669.

    (a) Effect of other distributions. The income of the beneficiary, 
for any of his prior taxable years for which a tax is being recomputed 
under Sec. 1.669(b)-1A, shall include any amounts of prior accumulation 
distributions (including prior capital gain distributions) deemed 
distributed under sections 666 and 669 in such prior taxable year. For 
purposes of the preceding sentence, a prior accumulation distribution is 
a distribution from the same or another trust which was paid, credited, 
or required to be distributed in a prior taxable year of the 
beneficiary. The term prior accumulation distribution also includes 
accumulation distributions of the same or other trusts which were 
distributed to the beneficiary in the same taxable year. The term 
``prior capital gain distribution'' also includes capital gain 
distributions of other trusts which were paid, credited, or required to 
be distributed to the beneficiary in the same taxable year and which the 
beneficiary has determined under paragraph (b) of this section to treat 
as having been distributed before the capital gain distribution for 
which tax is being computed under Sec. 1.669(b)-1A.
    (b) Multiple distributions in the same taxable year. For purposes of 
paragraph (a) of this section, capital gain distributions made from more 
than one trust in the same taxable year of the beneficiary, regardless 
of when in the taxable year they were actually made, shall be treated as 
having been made consecutively, in whichever order the beneficiary may 
determine. However, the beneficiary must treat them as having been made 
in the same order for the purpose of computing the partial tax on the 
several capital gain distributions. The beneficiary shall indicate the 
order he has determined to deem the capital gain distributions to have 
been received by him on his return for the taxable year. A failure by 
him so to indicate, however, shall not affect his right to make such 
determination. The purpose of this rule is to assure that the tax 
resulting from the later (as so deemed under this paragraph) 
distribution is computed with the inclusion of the earlier distribution 
in the taxable base and that the tax resulting from the earlier (as so 
deemed under this paragraph) distribution is computed with the later 
distribution excluded from the taxable base.
    (c) Rule when beneficiary not in existence on the last day of a 
taxable year. If a beneficiary was not in existence on the last day of a 
preceding taxable year of the trust with respect to which a distribution 
is deemed made under section 669(a), it shall be assumed, for purposes 
of the computations under paragraphs (b) and (c) of Sec. 1.669(b)-1A, 
that the beneficiary:
    (1) Was in existence on such last day,
    (2) Was a calendar year taxpayer,
    (3) Had no gross income other than the amounts deemed distributed to 
him from such trust in his calendar year in which such last day occurred 
and from all other trusts from which amounts are deemed to have been 
distributed to him in such calendar year,
    (4) If an individual, was unmarried and had no dependents,
    (5) Had no deductions other than the standard deduction, if 
applicable, under section 141 for such calendar year, and
    (6) Was entitled to the personal exemption under section 151 or 
642(b).

For example, assume that part of a capital gain distribution made in 
1980 is deemed under section 669(a) to have been distributed to the 
beneficiary, A, in 1973. $10,000 of a prior accumulation distribution 
was deemed distributed in 1973. A was born on October 9, 1975. It will 
be assumed for purposes of Sec. 1.669(b)-1A that A was alive in 1973, 
was on the calendar year basis, had no income other than (i) the $10,000 
from the accumulation distribution deemed distributed in 1973 and (ii) 
the part of the 1980 distribution deemed distributed in 1973, and had no 
deductions other than the personal exemption provided in section 151. If 
A were a trust or estate created after 1973, the same assumptions would 
apply, except that the trust or estate would not be entitled to the 
standard deduction and would receive the personal exemption provided 
under section 642(b) in the same manner as allowed under such section 
for A's first actual taxable year.
    (d) Examples. The provisions of paragraphs (a) and (b) of this 
section may

[[Page 228]]

be illustrated by the following examples:

    Example 1. In 1978, trust X made a capital gain distribution to A, a 
calendar year taxpayer, of which $3,000 was deemed to have been 
distributed in 1974. In 1980, trust X makes another capital gain 
distribution to A, $10,000 of which is deemed under section 669(a) to 
have been distributed in 1974. Also in 1980, trust Y makes a capital 
gain distribution to A, of which $5,000 is deemed under section 669(a) 
to have been distributed in 1974. A determines to treat the 1980 
distribution from trust Y as having been made prior to the 1980 
distribution from trust X. In computing the tax on the 1980 trust Y 
distribution, A's gross income for 1974 includes (i) the $3,000 deemed 
distributed from the 1978 distribution, and (ii) the $5,000 deemed 
distributed in 1974 from the 1980 Trust Y capital gain distribution. To 
compute A's tax under the exact method for 1974 on the $10,000 from the 
1980 trust X capital gain distribution deemed distributed in 1974. A's 
gross income for 1974 includes (i) the $10,000, (ii) the $3,000 
previously deemed distributed in 1974 from the 1978 trust X capital gain 
distribution, and (iii) the $5,000 deemed distributed in 1974 from the 
1980 trust Y capital gain distribution.
    Example 2. In 1978, trust T makes a capital gain distribution to B, 
a calendar year taxpayer. Determination of the tax on the distribution 
under the short-cut method requires the use of B's gross income for 
1975, 1976, and 1977. In 1977, B received an accumulation distribution 
from trust U, of which $2,000 was deemed to have been distributed in 
1975, and $3,000 in 1976. B's gross income for 1975, for purposes of 
using the short-cut method to determine the tax from the trust T capital 
gain distribution, will be deemed to include the $2,000 deemed 
distributed in 1975 by trust U, and his gross income for 1976 will be 
deemed to include the $3,000 deemed distributed by trust U in 1976.

[T.D. 7204, 37 FR 17155, Aug. 25, 1972]



Sec. 1.669(c)-2A   Computation of the beneficiary's income and tax for a prior taxable year.

    (a) Basis for computation. (1) The beneficiary's income and tax paid 
for any prior taxable year for which a recomputation is involved under 
either the exact method or the short-cut method shall be determined by 
reference to the information required to be furnished by him under 
Sec. 1.669(c)-3A(a). The gross income, related deductions, and taxes 
paid for a prior taxable year of the beneficiary as finally determined 
shall be used for recomputation purposes. The term as finally determined 
shall have the same meaning for purposes of this section as in 
Sec. 1.668(b)-3A(a).
    (2) If any computations rely on the beneficiary's return for a prior 
taxable year for which the applicable period of limitations on 
assessment under section 6501 has expired, and such return shows a 
mathematical error on its face which resulted in the wrong amount of tax 
being paid for such year, the determination of both the tax for such 
year computed with the inclusion of the section 669 amounts in the 
beneficiary's gross income, and the tax for such year computed without 
including such amounts in such gross income, shall be based upon the 
return after the correction of such mathematical errors.
    (b) Effect of allocation of undistributed capital gain on items 
based on amount of income and with respect to a net operating loss, a 
charitable contributions carryover, or a capital loss carryover. (1) In 
computing the tax for any taxable year under either the exact method or 
the short-cut method, any item which depends upon the amount of gross 
income, adjusted gross income, or taxable income shall be recomputed to 
take into consideration the amount of undistributed capital gain 
allocated to such year. For example, if $2,000 of undistributed long-
term capital gain is allocated to 1970, adjusted gross income for 1970 
is increased from $5,000 to $6,000. The allowable 50 percent charitable 
deduction under section 170(b)(1)(A) is then increased and the amount of 
the nondeductible medical expenses under section 213 (3 percent of 
adjusted gross income) is also increased.
    (2) In computing the tax attributable to the undistributed capital 
gain deemed distributed to the beneficiary in any of his prior taxable 
years under either the exact method or the short-cut method, the effect 
of amounts of undistributed capital gain on a net operating loss 
carryback or carryover, a charitable contributions carryover, or a 
capital loss carryback or carryover, shall be taken into account. In 
determining the amount of tax attributable to such deemed distribution, 
a computation shall also be made for any taxable year which is affected 
by a net operating loss carryback or carryover,

[[Page 229]]

by a charitable contributions carryover, or by a capital loss carryback 
or carryover determined by reference to the taxable year to which 
amounts are allocated under either method and which carryback or 
carryover is reduced or increased by such amounts so allocated.

[T.D. 7204, 37 FR 17155, Aug. 25, 1972]



Sec. 1.669(c)-3A   Information requirements with respect to beneficiary.

    (a) Information to be supplied by beneficiary--(1) Use of exact 
method. The beneficiary must supply the information required by 
subparagraph (3) of Sec. 1.668(b)-4A(a) for any prior taxable year for 
which a recomputation is required under either the exact method or the 
short-cut method. Such information shall be filed with the beneficiary's 
return for the year in which the tax under section 668(a)(3) is imposed.
    (2) Failure to furnish. If the beneficiary fails to furnish the 
information required by this paragraph for any prior year involved in 
the exact method, he may not use such method and the tax computed under 
paragraph (c) of Sec. 1.669(b)-1A (the short-cut method) shall be deemed 
to be the amount of partial tax imposed by section 668(a)(3). See, 
however, paragraph (b) of this section for an exception to this rule 
where the short-cut method is not permitted. If he cannot furnish the 
information required for a prior year involved in the short-cut method, 
such year will be recomputed on the basis of the best information 
available.
    (b) Exception. If, by reason of Sec. 1.669(b)-1A(e), the beneficiary 
may not compute the partial tax on the capital gain distribution under 
Sec. 1.669(b)-1A(c) (the short-cut method), the provisions of 
subparagraph (2) of paragraph (a) of this section shall not apply. In 
such case, if the beneficiary fails to provide the information required 
by Sec. 1.668(b)-4A(a)(3) for any prior taxable year, the district 
director shall, by utilizing whatever information is available to him 
(including information supplied by the beneficiary), determine the 
beneficiary's income and related expenses for such prior taxable year.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(d)-1A   Total taxes deemed distributed.

    (a) If a capital gain distribution is deemed under Sec. 1.669(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is not less than the undistributed capital gain for such 
preceding taxable year, then an additional amount equal to the ``taxes 
imposed on the trust attributable to the undistributed capital gain'' 
(as defined in Sec. 1.665(d)-1A(c)) for such preceding taxable year is 
also deemed to have been properly distributed. For example, assume a 
trust has no distributable net income and has undistributed capital gain 
of $18,010 for the taxable year 1974. The taxes imposed on the trust 
attributable to the undistributed capital gain are $2,190. During the 
taxable year 1977, a capital gain distribution of $18,010 is made to the 
beneficiary which is deemed under Sec. 1.669(a)-1A to have been 
distributed on the last day of 1974. The 1977 capital gain distribution 
is not less than the 1974 undistributed capital gain. Accordingly, taxes 
of $2,190 imposed on the trust attributable to the undistributed capital 
gain for 1974 are also deemed to have been distributed on the last day 
of 1974. Thus, a total of $20,200 will be deemed to have been 
distributed on the last day of 1974.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed capital gain of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed capital gain are computed after taking into account 
any capital gain distributions of taxable years intervening between such 
preceding taxable year and the taxable year. See paragraph (c) of 
Sec. 1.669(a)-1A.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(e)-1A   Pro rata portion of taxes deemed distributed.

    (a) If a capital gain distribution is deemed under Sec. 1.669(a)-1A 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed capital gain for such preceding 
taxable year, then an additional amount is also deemed to have been 
properly distributed. The additional amount is equal to the ``taxes 
imposed on the trust attributable to

[[Page 230]]

the undistributed capital gain'' (as defined in Sec. 1.665(d)-1A(c)) for 
such preceding taxable year, multiplied by a fraction, the numerator of 
which is the amount of the capital gain distribution allocated to such 
preceding taxable year and the denominator of which is the undistributed 
capital gain for such preceding taxable year. See paragraph (b) of 
example 1 and paragraphs (c) and (f) of example 2 in Sec. 1.669(e)-2A 
for illustrations of this paragraph.
    (b) For the purpose of paragraph (a) of this section, the 
undistributed capital gain of any preceding taxable year and the taxes 
imposed on the trust for such preceding taxable year attributable to 
such undistributed capital gain are computed after taking into account 
any capital gain distributions of any taxable years intervening between 
such preceding taxable year and the taxable year. See paragraph (c) of 
Sec. 1.669(a)-1A, paragraph (c) of example 1 and paragraphs (e) and (h) 
of example 2 in Sec. 1.669(e)-2A.

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(e)-2A  Illustration of the provisions of section 669.

    The application of the provisions of Secs. 1.669(a)-1A, 1.669(d)-1A, 
and 1.669(e)-1A may be illustrated by the following examples:

    Example 1. (a) A trust created on January 1, 1974, makes capital 
gain distributions as follows:

1979.............................................................$14,000
1980..............................................................60,000

The trust had accumulated income in 1974.

For 1974 through 1978, the undistributed portion of capital gain, taxes 
imposed on the trust attributable to the undistributed capital gain, and 
undistributed capital gain are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                 Taxes imposed on               
                                                                 Undistributed      the trust                   
                              Year                                 portion of    attributable to   Undistributed
                                                                  capital gain  the undistributed   capital gain
                                                                                   capital gain                 
----------------------------------------------------------------------------------------------------------------
1974...........................................................   $24,200           $2,830          $21,370     
1975...........................................................    32,200            4,330           27,870     
1976...........................................................    12,200            1,130           11,070     
1977...........................................................      None             None             None     
1978...........................................................    10,200              910            9,290     
----------------------------------------------------------------------------------------------------------------

    (b) Since the entire amount of the capital gain distribution for 
1979 ($14,000), determined without regard to the capital gain 
distribution for 1980, is less than the undistributed capital gain for 
1974 ($21,370), an additional amount of $1,854 (14,000/21,370 x  $2,830) 
is deemed distributed under section 669(e).
    (c) In allocating the capital gain distribution for 1980, the amount 
of undistributed capital gain for 1974 will reflect the capital gain 
distribution for 1979. The undistributed capital gain for 1974 will then 
be $7,370 and the taxes imposed on the trust for 1974 will be $976, 
determined as follows:

Undistributed capital gain as of the close of 1974..........     $21,370
Less: Capital gain distribution (1979)......................      14,000
                                                             -----------
    Balance (undistributed capital gain as of the close of              
     1979)..................................................       7,370
Taxes imposed on the trust attributable to the undistributed            
 capital gain as of the close of 1979 (7,370/ 21,370 x                  
 2,830).....................................................         976
                                                                        

    (d) The capital gain distribution of $60,000 for 1980 is deemed to 
have been made on the last day of the preceding taxable years of the 
trust to the extent of $55,600, the total of the undistributed capital 
gain for such years, as shown in the tabulation below. In addition, 
$7,346, the total taxes imposed on the trust attributable to the 
undistributed capital gain for such years is also deemed to have been 
distributed on the last day of such years, as shown below:

------------------------------------------------------------------------
                                                       Taxes imposed on 
                                                           the trust    
                 Year                  Undistributed    attributable to 
                                        capital gain   the undistributed
                                                         capital gain   
------------------------------------------------------------------------
1974.................................    $7,370              $976       
1975.................................    27,870             4,330       
1976.................................    11,070             1,130       
1977.................................      None              None       
1978.................................     9,290               910       
1979.................................      None              None       
                                      ----------------------------------
    Total............................    55,600             7,346       
------------------------------------------------------------------------

    Example 2. (a) Under the terms of a trust instrument, the trustee 
has discretion to accumulate or distribute the income to X and to invade 
corpus for the benefit of X. The trust is subject to capital gain 
throwback. Both X and the trust report on the calendar year basis. All 
of the income for 1974 was distributed and the capital gain was 
accumulated. The capital gain of the trust for the taxable year 1974 is 
$40,200 and the income taxes paid by the trust for 1974 attributable to 
the undistributed capital gain are $6,070. All of the income and capital 
gains for 1975 and 1976 were distributed and in addition the trustee 
made capital gain distributions within the meaning of section 665(g) of 
$8,000 for each year.
    (b) The undistributed capital gain of the trust determined under 
section 665(f) as of the close of 1974 is $34,130, computed as follows:

Capital gain................................................     $40,200

[[Page 231]]

                                                                        
    Less: Taxes imposed on the trust attributable to the                
     undistributed capital gain.............................       6,070
                                                             -----------
    Undistributed capital gain as of the close of 1974......      34,130
                                                                        

    (c) The capital gain distribution of $8,000 made during the taxable 
year 1975 is deemed under section 669(a) to have been made on December 
31, 1974. Since this capital gain distribution is less than the 1974 
undistributed capital gain of $34,130, a portion of the taxes imposed on 
the trust for 1974 is also deemed under section 669(e) to have been 
distributed on December 31, 1974. The total amount deemed to have been 
distributed to X on December 31, 1974, is $9,486, computed as follows:

Capital gain distribution...................................      $8,000
Taxes deemed distributed (8,000/ 34,130 x $6,070)...........       1,423
                                                             -----------
    Total...................................................       9,423
                                                                        

    (d) After the application of the provisions of subpart D to the 
capital gain distribution of 1975, the undistributed capital gain of the 
trust for 1974 is $26,130, computed as follows:

Undistributed capital gain as of the close of 1974..........     $34,130
    Less: 1975 capital gain distribution deemed distributed             
     on December 31, 1974 (paragraph (c) of this example)...       8,000
                                                             -----------
    Undistributed capital gain for 1974 as of the close of              
     1975...................................................      26,130
                                                                        

    (e) The taxes imposed on the trust attributable to the undistributed 
capital gain for the taxable year 1974, as adjusted to give effective to 
the 1975 capital gain distribution, amount to $4,647, computed as 
follows:

Taxes imposed on the trust attributable to undistributed                
 capital gain as of the close of 1974.......................      $6,070
    Less: Taxes deemed distributed in 1974..................       1,423
                                                             -----------
    Taxes attributable to the undistributed capital gain                
     determined as of the close of 1975.....................       4,647
                                                                        

    (f) The capital gain distribution of $8,000 made during the taxable 
year 1976 is, under section 669(a), deemed an amount properly 
distributed to X on December 31, 1974. Since the capital gain 
distribution is less than the 1974 adjusted undistributed capital gain 
of $26,130, the trust is deemed under section 669(e) also to have 
distributed on December 31, 1974, a portion of the taxes imposed on the 
trust for 1974. The total amount deemed to be distributed on December 
31, 1974, with respect to the capital gain distribution made in 1976, is 
$9,423, computed as follows:

Capital gain distribution...................................      $8,000
Taxes deemed distributed (8,000/ 26,130 x $4,647)...........       1,423
                                                             -----------
    Total...................................................       9,423
                                                                        

    (g) After the application of the provisions of subpart D to the 
capital gain distribution of 1976, the undistributed capital gain of the 
trust for 1974 is $18,130, computed as follows:

Undistributed capital gain for 1974 as of the close of 1975.     $26,130
Less:                                                                   
  1976 capital gain distribution deemed distributed on                  
   December 31, 1974 (paragraph (f) of this example)........       8,000
                                                             -----------
  Undistributed capital gain for 1974 as of the close of                
   1976.....................................................      18,130
                                                                        

    (h) The taxes imposed on the trust attributable to the undistributed 
capital gain of the trust for the taxable year 1974, determined as of 
the close of the taxable year 1976, amount to $3,224 ($4,647 less 
$1,423).

[T.D. 7204, 37 FR 17156, Aug. 25, 1972]



Sec. 1.669(f)-1A   Character of capital gain.

    Amounts distributed as a capital gain distribution and the taxes 
attributable thereto (determined under Sec. 1.665(d)-1A(c)) retain the 
character that the gain had with respect to the trust. Thus, a capital 
gain that was taxed to the trust as a ``long-term'' capital gain and the 
pro rata amount of taxes attributable to such long-term gain shall be 
treated to the beneficiary as a ``long-term'' capital gain when they are 
deemed distributed as part of a capital gain distribution. If a trust 
has different types of capital gain for the same taxable year, and all 
of the capital gains are not deemed distributed for such year under 
section 669(a), the amount deemed distributed from such year (including 
taxes deemed distributed) shall be treated as consisting of the 
different types of gains in the ratio that the total of each such type 
of gains of the trust bears to the total of all such gains for the 
taxable year. For example, assume that in 1975 a trust had net long-term 
capital gains of $4,000 and net short-term capital gains of $2,000. 
Taxes attributable to

[[Page 232]]

such undistributed capital gain were $700. Therefore, undistributed 
capital gain for 1975 is $5,300. In 1980, the trust distributes $2,650 
that is deemed to be undistributed capital gain from 1975. Such 
distribution is deemed to consist of long-term gain of $1,766.67 and 
short-term gain of $883.33. The taxes deemed distributed of $350 consist 
of long-term gain of $233.33 and short-term gain of $116.67.

[T.D. 7204, 37 FR 17157, Aug. 25, 1972]



Sec. 1.669(f)-2A   Exception for capital gain distributions from certain trusts.

    (a) General rule. If a capital gain distribution is paid, credited, 
or required to be distributed before January 1, 1973, from a trust that 
was in existence on December 31, 1969, section 669 shall not apply and 
no tax shall be imposed on such capital gain distribution under section 
668(a)(3). If capital gain distributions from more than one such trust 
are paid, credited, or required to be distributed to a beneficiary 
before January 1, 1973, the exception under the preceding sentence shall 
apply only to the capital gain distributions from one of the trusts. The 
beneficiary shall indicate on his income tax return for the taxable year 
in which the distribution would otherwise be included in income under 
section 668(a) the trust to which the exception provided by this section 
shall apply.
    (b) Special rule for section 2056(b)(5) trust. A capital gain 
distribution paid, credited, or required to be distributed by a trust 
that qualifies under section 2056(b)(5) of the Code (commonly known as a 
``marital deduction trust'') to a surviving spouse shall, in general, 
not be taxed under section 668(a)(3) since such a trust is required to 
distribute all of its income annually or more often. See section 
2056(b)(5) and the regulations thereunder.
    (c) Effect of exception. If this section applies to a capital gain 
distribution from a trust, such distribution shall reduce the 
undistributed capital gain of the trust. Since section 669 does not 
apply to such capital gain distribution, no amount of taxes paid by the 
trust attributable to such capital gain distribution are deemed 
distributed under section 669 (d) and (e).

[T.D. 7204, 37 FR 17157, Aug. 25, 1972]



Sec. 1.669(a)-1   Limitation on tax.

    (a) In general. Section 669 provides that, at the election of a 
beneficiary who is a U.S. person (as defined in section 7701(a)(30)) and 
who satisfies the requirements of section 669(b) (that certain 
information with respect to the operation and accounts of the trust be 
supplied), the tax attributable to the amounts treated under section 
668(a) as having been received by him, from a foreign trust created by a 
U.S. person, on the last day of a preceding taxable year of the trust 
shall not be greater than the tax computed under section 669(a)(1)(A) 
(the computation under this provision will hereinafter be referred to as 
the ``exact throwback'' method) or under section 669(a)(1)(B) (the 
computation under this provision will hereinafter be referred to as the 
``short-cut throwback'' method). This election of the beneficiary with 
respect to the taxable year of the beneficiary in which the distribution 
is made shall be made with the district director before the expiration 
of the period of limitations for assessment provided in section 6501 for 
such taxable year.
    (b) Where no election is made. If the beneficiary does not make the 
election provided in section 669(a) in the manner required in section 
669(b) and Sec. 1.669(b)-2, or furnish the information with respect to 
the operation and accounts of the foreign trust created by a U.S. person 
required by section 669(b) and Sec. 1.669(b)-1, the tax on an 
accumulation distribution treated under section 668(a) as having been 
received by him from such foreign trust on the last day of a preceding 
taxable year of the trust shall be computed without reference to section 
668 or 669. In such case, the entire accumulation distribution will be 
included in the gross income of the beneficiary in the year in which it 
is paid, credited, or required to be distributed, and tax for such year 
will be computed on the basis of the beneficiary's total taxable income 
for the year after taking into account such inclusion in gross income.
    (c) Year for which tax is payable. The tax, regardless of the manner 
in which

[[Page 233]]

computed, of the beneficiary which is attributable to an accumulation 
distribution is imposed on the beneficiary for the taxable year of the 
beneficiary in which the accumulation distribution is made to him unless 
the taxable year of the beneficiary is different from that of the trust. 
See section 662(c) and Sec. 1.662(c)-1.

[T.D. 6989, 34 FR 738, Jan. 17, 1969]



Sec. 1.669(a)-2   Rules applicable to section 669 computations.

    (a) In general. (1) Section 668(a) provides that the total of the 
amounts treated under section 666 as having been distributed by the 
foreign trust created by a U.S. person on the last day of a preceding 
taxable year of such trust shall be included in the gross income of the 
beneficiary or the beneficiaries who are U.S. persons receiving them. 
The total of such amounts is includible in the gross income of each 
beneficiary to the extent the amount would have been included in his 
gross income under section 662 (a)(2) and (b) if the total had actually 
been paid by the trust on the last day of such preceding taxable year. 
The total is included in the gross income of the beneficiary for the 
taxable year of the beneficiary in which such amounts are in fact paid, 
credited, or required to be distributed unless the taxable year of the 
beneficiary differs from the taxable year of the trust (see section 
662(c) and Sec. 1.662(c)-1). The character of the amounts treated as 
received by a beneficiary in prior taxable years, including taxes deemed 
distributed, in the hands of the beneficiary is determined by the rules 
contained in section 662(b) and Secs. 1.662(b)-1 and 1.662(b)-2.
    (2) The total of the amounts treated under section 666 as having 
been distributed by the trust on the last day of a preceding taxable 
year of the trust are included as prescribed in subparagraph (1) of this 
paragraph in the gross income of the beneficiary even though as of that 
day the beneficiary would not have been entitled to receive them had 
they actually been distributed on that day.
    (3) Any deduction allowed to the trust in computing distributable 
net income for a preceding taxable year (such as depreciation, 
depletion, etc.) is not deemed allocable to a beneficiary because of the 
amounts included in a beneficiary's gross income under this section 
since the deduction has already been utilized in reducing the amount 
included in the beneficiary's income.
    (b) Allocation among beneficiaries of a foreign trust. Where there 
is more than one beneficiary the portion of the total amount includible 
in gross income under paragraph (a) of this section which is includible 
in the gross income of a beneficiary who is a U.S. person is based upon 
the ratio determined under the second sentence of section 662(a)(2) for 
the taxable year in which distributed (and not for the preceding taxable 
year). This paragraph may be illustrated by the example in 
Sec. 1.668(a)-2.
    (c) Treatment of income taxes paid by the trust--(1) Current 
distributions. The income taxes imposed by the provisions of section 871 
on the income of a foreign trust created by a U.S. person shall be 
included in the gross income of the beneficiary, who is a U.S. person, 
for the taxable year in which such income is paid, credited, or required 
to be distributed to the beneficiary.
    (2) Accumulation distribution. (i) If an accumulation distribution 
is deemed under Sec. 1.666(a)-1 to be distributed on the last day of a 
preceding taxable year and the amount is not less than the undistributed 
net income for such preceding taxable year, then an additional amount 
equal to the taxes imposed on the trust pursuant to the provisions of 
section 871 for such preceding taxable year is likewise deemed 
distributed under section 661(a)(2).
    (ii) If an accumulation distribution is deemed under Sec. 1.666(a)-1 
to be distributed on the last day of a preceding taxable year and the 
amount is less than the undistributed net income for such preceding 
taxable year, then an additional amount (representing taxes) is likewise 
deemed distributed under section 661(a)(2). The additional amount is 
equal to the taxes imposed on the trust pursuant to the provisions of 
section 871 for such preceding taxable year, multiplied by the fraction 
the numerator of which is the amount of the accumulation distribution 
attributable to

[[Page 234]]

such preceding taxable year and the denominator of which is the 
undistributed net income for such preceding taxable year.
    (3) Credits under sections 32 and 668(b). Credit under section 32 is 
allowable to the beneficiary for income taxes withheld at source under 
subchapters A and B of chapter 3 and which are deemed distributed to 
him. Credit under section 668(b) is allowable to the beneficiary for 
income taxes imposed upon the foreign trust by section 871(b). These 
credits shall be allowed against the tax of the beneficiary for the 
taxable year of the beneficiary in which the income is paid, credited, 
or required to be distributed to him, or in which the accumulation 
distribution to which such taxes relate is made to him.
    (d) Credit for foreign income taxes paid by the trust. To the extent 
provided in section 901, credit under section 33 is allowable to the 
beneficiary for the foreign taxes paid or accrued by the trust to a 
foreign country.

[T.D. 6989, 34 FR 738, Jan. 17, 1969]



Sec. 1.669(a)-3   Tax computed by the exact throwback method.

    (a) Tax attributable to amounts treated as received in preceding 
taxable years. If a taxpayer elects to compute the tax, on amounts 
deemed distributed under section 666, by the exact throwback method 
provided in section 669(a)(1)(A), the tax liability of the beneficiary 
for the taxable year in which the accumulation distribution is paid, 
credited, or required to be distributed is computed as provided in 
paragraph (b) of this section. The beneficiary may not elect to use the 
exact throwback method of computing his tax on an accumulation 
distribution as provided in section 669(a)(1)(A) if he were not alive on 
the last day of each preceding taxable year of the foreign trust created 
by a U.S. person with respect to which a distribution is deemed made 
under section 666(a). Thus, if a portion of an amount received as an 
accumulation distribution was accumulated by the trust during years 
before the beneficiary was born, the beneficiary is not permitted to 
elect the exact throwback method provided in section 669(a)(1)(A). See 
Sec. 1.669(a)-4 for the computation of the tax on an accumulation 
distribution by the short-cut throwback method provided in section 
669(a)(1)(B) under these circumstances.
    (b) Computation of tax. The tax referred to in paragraph (a) of this 
section is computed as follows:
    (1) First, compute the tax attributable to the section 666 amounts 
for each of the preceding taxable years. To determine the section 666 
amounts attributable to each of the preceding taxable years, see 
Sec. 1.666(a)-1. The tax attributable to such amounts in each such 
preceding taxable year is the difference between the tax for such 
preceding taxable year computed with the inclusion of the section 666 
amounts in gross income, and the tax for such year computed without 
including them in gross income. Tax computations for each preceding year 
shall reflect the taxpayer's marital and dependency status for that 
year.
    (2) Second, add
    (i) The sum of the taxes for the preceding taxable years 
attributable to the section 666 amounts (computed in accordance with 
subparagraph (1) of this paragraph), and
    (ii) The tax for the taxable year of the beneficiary in which the 
accumulation distribution is paid, credited, or required to be 
distributed to him, computed without including the section 666 amounts 
in gross income.

The total of these amounts is the beneficiary's tax, computed under 
section 669(a)(1)(A) for the taxable year in which the accumulation 
distribution is paid, credited, or required to be distributed to him.
    (c) Effect of prior election. In computing the tax attributable to 
an accumulation distribution for the taxable year in which such 
accumulation distribution is paid, credited, or required to be 
distributed to him, the beneficiary in computing the tax attributable to 
section 666 amounts for each of the preceding taxable years, must 
include in his gross income for each such year the section 666 amounts 
deemed distributed to him in such year resulting from prior accumulation 
distributions made to him in taxable years prior to the current taxable 
year. These section 666 amounts resulting from such prior accumulation 
distributions must be included in the gross income for such

[[Page 235]]

preceding taxable year even though the tax on the accumulation 
distribution of such prior taxable year was computed by the short-cut 
throwback method provided in section 669(a)(1)(B) and Sec. 1.669(a)-4.

[T.D. 6989, 34 FR 739, Jan. 17, 1969]



Sec. 1.669(a)-4   Tax attributable to short-cut throwback method.

    (a) Manner of computing tax. If a beneficiary has elected under 
section 669(a) to compute the tax on the amounts deemed distributed 
under section 666 by the short-cut throwback method provided in section 
669(a)(1)(B), the tax liability of the beneficiary for the taxable year 
is computed in the following manner:
    (1) First, determine the number of preceding taxable years of the 
trust, on the last day of which an amount is deemed under section 666(a) 
to have been distributed. In any case where there has been a prior 
accumulation distribution with respect to which the beneficiary has 
elected to compute his tax either by the exact throwback method or by 
the short-cut throwback method, or to which the next to the last 
sentence of section 668(a) has applied, for purposes of an election to 
use the short-cut throwback method with respect to a subsequent 
accumulation distribution, in determining the number of preceding 
taxable years of the trust with respect to which an amount of the 
subsequent accumulation distribution is deemed distributed to a 
beneficiary under section 666(a), there shall be excluded any preceding 
taxable year during which any part of the prior accumulation 
distribution was deemed distributed to the beneficiary. For example, 
assume that an accumulation distribution of $90,000 made to a 
beneficiary in 1963 is deemed distributed in the amounts of $25,000 in 
each of the years 1962, 1961, and 1960, and in the amount of $15,000 in 
1959, and a subsequent accumulation distribution of $85,000 made to the 
same beneficiary in 1964 is deemed distributed in the amount of $10,000 
during 1959, and $25,000 during each of the years 1958, 1957, and 1956. 
The accumulation distribution made in 1963 is deemed distributed in 4 
preceding taxable years of the trust (1962, 1961, 1960, and 1959). 
Inasmuch as the year 1959 was a year during which part of the 1963 
accumulation distribution was deemed distributed, for purposes of 
determining the number of preceding taxable years in which the 
accumulation distribution of $85,000 made in 1964 is deemed distributed, 
the year 1959 is excluded and the $85,000 accumulation distribution is 
deemed distributed in three preceding taxable years (1958, 1957, and 
1956),
    (2) Second, divide the number of preceding taxable years of the 
trust, on the last day of which an amount is deemed under section 666(a) 
to have been distributed (determined as provided in subparagraph (1) of 
this paragraph) into the amount (representing an accumulation 
distribution made by a foreign trust created by a U.S. person) required 
to be included under section 669(a) in the gross income of the 
beneficiary for the taxable year,
    (3) Third, compute the tax of the beneficiary for the current 
taxable year (the year in which the accumulation distribution is paid, 
credited, or required to be distributed to him) and for each of the 2 
taxable years immediately preceding such year,
    (i) With the inclusion in gross income of the beneficiary for each 
of such 3 years of the amount determined under subparagraph (2) of this 
paragraph, and
    (ii) Without such inclusion.

The difference between the amount of tax computed under subdivision (i) 
of this subparagraph for each year and the amount computed under 
subdivision (ii) of this subparagraph for that year is the additional 
tax resulting from the inclusion in gross income for that year of the 
amount determined under subparagraph (2) of this paragraph. If the 
number of preceding taxable years of the trust, on the last day of which 
an amount is deemed under section 666(a) to have been distributed, is 
less than three, the taxable years of the beneficiary for which this 
recomputation is made shall equal the number of years in which an amount 
is deemed under section 666(a) to have been distributed, commencing with 
the taxable year of the beneficiary in which the accumulation 
distribution is paid, credited, or required to be distributed to him. If 
the beneficiary was not alive during one of the two taxable

[[Page 236]]

years immediately preceding the taxable year, the tax resulting from the 
inclusion of the amount determined in subparagraph (2) of this paragraph 
in the gross income of the beneficiary will be computed only for the 
taxable year in which the accumulation distribution was paid, credited, 
or required to be distributed to him and the preceding year during which 
the beneficiary was alive. In the event the beneficiary was not alive 
during either of the 2 years immediately preceding the taxable year in 
which the accumulation distribution was paid, credited, or required to 
be distributed, the tax shall be computed on the basis of the 
beneficiary's taxable year without regard to the inclusion in income 
required by section 668(a) of any amount other than pursuant to section 
669(a)(1)(B). For example, assume that a foreign trust created by a U.S. 
person accumulates $3,000 of income in 1964 and $7,000 in 1963 and then 
distributes the accumulated income on January 1, 1965, to a beneficiary 
who is a U.S. person. The limitation on tax is determined by recomputing 
the beneficiary's gross income for 1964 and 1965 by adding $5,000 to his 
gross income for each year. If the same distribution were made to an 
infant who was born in 1965, the limitation on tax would be computed by 
adding $5,000 to his gross income for such year. In the case of the 
infant, the resulting increase in tax would be multiplied by two to 
arrive at the limitation on the increase in his tax for 1965 
attributable to such distribution.
    (4) Fourth, add the additional taxes resulting from the application 
of subparagraph (3) of this paragraph for the taxable year and the 2 
taxable years (or the 1 taxable year, where applicable) immediately 
preceding the year in which the accumulation distribution is paid, 
credited, or required to be distributed and then divide this amount by 
three (or two, where applicable). The resulting amount is then 
multiplied by the number of preceding taxable years of the trust on the 
last day of which an amount is deemed under section 666(a) to have been 
distributed (previously determined under subparagraph (1) of this 
paragraph). The resulting amount is the tax, under the short-cut 
throwback method provided in section 669(a)(1)(B), which is attributable 
to the amounts treated under section 668(a) as having been received by 
the beneficiary from a foreign trust created by a U.S. person on the 
last day of the preceding taxable year.
    (5) Fifth, add the amount determined under subparagraph (4) of this 
paragraph to the beneficiary's tax for the taxable year in which the 
accumulation distribution was paid, credited, or required to be 
distributed to him, computed without inclusion of the accumulation 
distribution in gross income for that year. The total is the 
beneficiary's income tax for such year.
    (b) Credit for tax paid by trust. The income taxes deemed 
distributed to a beneficiary in the manner described in paragraphs (c) 
and (d) of Sec. 1.669(a)-2 are included in the beneficiary's gross 
income for purposes of the computations required by this section. To the 
extent provided in Sec. 1.669(a)-2, credits for such taxes are allowable 
to the beneficiary. In the computations under the short-cut throwback 
method provided in section 669(a)(1)(B), the rules set forth in section 
662(b) and Sec. 1.662(b)-1 shall be applied in determining the 
character, in the hands of the beneficiary, of the amounts, including 
taxes includible in the distribution or deemed distributed, treated as 
received by a beneficiary in prior taxable years. For example, if one-
fifth of such amounts represents tax-free income, then one-fifth of the 
amount determined under paragraph (a)(2) of this section shall be 
treated as tax-free income.

[T.D. 6989, 34 FR 739, Jan. 17, 1969]



Sec. 1.669(b)-1   Information requirements.

    The election of a beneficiary who is a U.S. person to apply the 
limitations on tax provided in section 669(a) shall not be effective 
unless the beneficiary, at or before the time the election is made, 
supplies, in a letter addressed to the district director for the 
internal revenue district in which the taxpayer files his return (or the 
Director of International Operations where appropriate), or in a 
statement attached to his return, the following information with respect 
to the operation and accounts of the foreign trust created by a U.S. 
person for each of the preceding taxable years, on the last day of which

[[Page 237]]

an amount is deemed distributed under section 666(a):
    (a) The gross income of the trust: The gross income should be 
separated to show the amount of each type of income received by the 
trust and to identify its source. For example, the beneficiary should 
list separately, by type (dividends, rents, capital gains, taxable 
interest, exempt interest, etc.) and source (name and country of payor), 
each item of income included in the gross income of the trust. For this 
purpose, the gross income of the trust includes gross income from U.S. 
sources which is exempt from taxation under section 894.
    (b) The amount of tax withheld under section 1441 by the United 
States on income from sources within the United States.
    (c) The amount of the tax paid to each foreign country by the trust.
    (d) The expenses of the trust attributable to each type of income 
disclosed in paragraph (b) of this section, and the general expenses of 
the trust.
    (e) The distributions, if any, made by the trust to the 
beneficiaries (including those who are not U.S. persons). These 
distributions should be separated into amounts of income required to be 
distributed currently within the meaning of section 661(a)(1), and any 
other amounts properly paid, credited, or required to be distributed 
within the meaning of section 661(a)(2).
    (f) Any other information which is necessary for the computation of 
tax on the accumulation distribution as provided in section 669(a).
    (g) If the foreign trust created by a U.S. person is less than the 
entire foreign trust, the information listed in paragraphs (a) through 
(f) of this section shall also be furnished with respect to that portion 
of the entire foreign trust which is not a foreign trust created by a 
U.S. person.

[T.D. 6989, 34 FR 740, Jan. 17, 1969]



Sec. 1.669(b)-2   Manner of exercising election.

    (a) By whom election is to be made. Except as otherwise provided in 
this paragraph, a taxpayer whose tax liability is affected by the 
election shall make the election provided in section 669(a). In the case 
of a partnership, or a corporation electing under the provisions of 
subchapter S, chapter 1 of the Code, the election shall be exercised by 
the partnership or such corporation.
    (b) Time and manner of making election. The election under section 
669(a) may be made, or revoked, at any time before the expiration of the 
period provided in section 6501 for assessment of the tax. If an 
election is revoked, a new election may be made at any time before the 
expiration of such period. The election (or a revocation of an election) 
may be made in a letter addressed to the district director of internal 
revenue for the district in which the taxpayer files his tax return (or 
the Director of International Operations where appropriate) or may be 
made in a statement attached to the return. In any case where all the 
information described in Sec. 1.669(b)-1 is not furnished at or before 
the time the beneficiary signifies his intention of making an election 
and by reason thereof an election has not been made, and subsequent 
thereto, but before the expiration of the period provided in section 
6501 for the assessment of the tax, there is furnished the required 
information not previously furnished, the election will be considered as 
made at the time such additional information is furnished.

[T.D. 6989, 34 FR 740, Jan. 17, 1969]

            grantors and others treated as substantial owners



Sec. 1.671-1   Grantors and others treated as substantial owners; scope.

    (a) Subpart E (section 671 and following), part I, subchapter J, 
chapter 1 of the Code, contains provisions taxing income of a trust to 
the grantor or another person under certain circumstances even though he 
is not treated as a beneficiary under subparts A through D (section 641 
and following) of such part I. Sections 671 and 672 contain general 
provisions relating to the entire subpart. Sections 673 through 677 
define the circumstances under which income of a trust is taxed to a 
grantor. These circumstances are in general as follows:
    (1) If the grantor has retained a reversionary interest in the 
trust, within specified time limits (section 673);

[[Page 238]]

    (2) If the grantor or a nonadverse party has certain powers over the 
beneficial interests under the trust (section 674);
    (3) If certain administrative powers over the trust exist under 
which the grantor can or does benefit (section 675).
    (4) If the grantor or a nonadverse party has a power to revoke the 
trust or return the corpus to the grantor (section 676); or
    (5) If the grantor or a nonadverse party has the power to distribute 
income to or for the benefit of the grantor or the grantor's spouse 
(section 677).

Under section 678, income of a trust is taxed to a person other than the 
grantor to the extent that he has the sole power to vest corpus or 
income in himself.
    (b) Sections 671 through 677 do not apply if the income of a trust 
is taxable to a grantor's spouse under section 71 or 682 (relating 
respectively to alimony and separate maintenance payments, and the 
income of an estate or trust in the case of divorce, etc.).
    (c) Except as provided in such subpart E, income of a trust is not 
included in computing the taxable income and credits of a grantor or 
another person solely on the grounds of his dominion and control over 
the trust. However, the provisions of subpart E do not apply in 
situations involving an assignment of future income, whether or not the 
assignment is to a trust. Thus, for example, a person who assigns his 
right to future income under an employment contract may be taxed on that 
income even though the assignment is to a trust over which the assignor 
has retained none of the controls specified in sections 671 through 677. 
Similarly, a bondholder who assigns his right to interest may be taxed 
on interest payments even though the assignment is to an uncontrolled 
trust. Nor are the rules as to family partnerships affected by the 
provisions of subpart E, even though a partnership interest is held in 
trust. Likewise, these sections have no application in determining the 
right of a grantor to deductions for payments to a trust under a 
transfer and leaseback arrangement. In addition, the limitation of the 
last sentence of section 671 does not prevent any person from being 
taxed on the income of a trust when it is used to discharge his legal 
obligation. See Sec. 1.662 (a)-4. He is then treated as a beneficiary 
under subparts A through D or treated as an owner under section 677 
because the income is distributed for his benefit, and not because of 
his dominion or control over the trust.
    (d) The provisions of subpart E are not applicable with respect to a 
pooled income fund as defined in paragraph (5) of section 642(c) and the 
regulations thereunder, a charitable remainder annuity trust as defined 
in paragraph (1) of section 664(d) and the regulations thereunder, or a 
charitable remainder unitrust as defined in paragraph (2) of section 
664(d) and the regulations thereunder.
    (e) For the effective date of subpart E see section 683 and the 
regulations thereunder.
    (f) For rules relating to the treatment of liabilities resulting on 
the sale or other disposition of encumbered trust property due to a 
renunciation of powers by the grantor or other owner, see Sec. 1.1001-2.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7148, 36 FR 
20749, Oct. 29, 1971; T.D. 7741, 45 FR 81745, Dec. 12, 1980]



Sec. 1.671-2   Applicable principles.

    (a) Under section 671 a grantor or another person includes in 
computing his taxable income and credits those items of income, 
deduction, and credit against tax which are attributable to or included 
in any portion of a trust of which he is treated as the owner. Sections 
673 through 678 set forth the rules for determining when the grantor or 
another person is treated as the owner of any portion of a trust. The 
rules for determining the items of income, deduction, and credit against 
tax that are attributable to or included in a portion of the trust are 
set forth in Sec. 1.671-3.
    (b) Since the principle underlying subpart E (section 671 and 
following), part I, subchapter J, chapter 1 of the Code, is in general 
that income of a trust over which the grantor or another person has 
retained substantial dominion or control should be taxed to the grantor 
or other person rather than to the trust which receives the income

[[Page 239]]

or to the beneficiary to whom the income may be distributed, it is 
ordinarily immaterial whether the income involved constitutes income or 
corpus for trust accounting purposes. Accordingly, when it is stated in 
the regulations under subpart E that ``income'' is attributed to the 
grantor or another person, the reference, unless specifically limited, 
is to income determined for tax purposes and not to income for trust 
accounting purposes. When it is intended to emphasize that income for 
trust accounting purposes (determined in accordance with the provisions 
set forth in Sec. 1.643(b)-1 is meant, the phrase ``ordinary income'' is 
used.
    (c) An item of income, deduction, or credit included in computing 
the taxable income and credits of a grantor or another person under 
section 671 is treated as if it had been received or paid directly by 
the grantor or other person (whether or not an individual). For example, 
a charitable contribution made by a trust which is attributed to the 
grantor (an individual) under sections 671 through 677 will be 
aggregated with his other charitable contributions to determine their 
deductibility under the limitations of section 170(b)(1). Likewise, 
dividends received by a trust from sources in a particular foreign 
country which are attributed to a grantor or another person under 
subpart E will be aggregated with his other income from sources within 
that country to determine whether the taxpayer is subject to the 
limitations of section 904 with respect to credit for the tax paid to 
that country.
    (d) Items of income, deduction, and credit not attributed to or 
included in any portion of a trust of which the grantor or another 
person is treated as the owner under subpart E are subject to the 
provisions of subparts A through D (section 641 and following), of such 
part I.
    (e) The term grantor as used in the regulations under subpart E 
includes a corporation.



Sec. 1.671-3   Attribution or inclusion of income, deductions, and credits against tax.

    (a) When a grantor or another person is treated under subpart E 
(section 671 and following) as the owner of any portion of a trust, 
there are included in computing his tax liability those items of income, 
deduction, and credit against tax attributable to or included in that 
portion. For example:
    (1) If a grantor or another person is treated as the owner of an 
entire trust (corpus as well as ordinary income), he takes into account 
in computing his income tax liability all items of income, deduction, 
and credit (including capital gains and losses) to which he would have 
been entitled had the trust not been in existence during the period he 
is treated as owner.
    (2) If the portion treated as owned consists of specific trust 
property and its income, all items directly related to that property are 
attributable to the portion. Items directly related to trust property 
not included in the portion treated as owned by the grantor or other 
person are governed by the provisions of subparts A through D (section 
641 and following), part I, subchapter J, chapter 1 of the Code. Items 
that relate both to the portion treated as owned by the grantor and to 
the balance of the trust must be apportioned in a manner that is 
reasonable in the light of all the circumstances of each case, including 
the terms of the governing instrument, local law, and the practice of 
the trustee if it is reasonable and consistent.
    (3) If the portion of a trust treated as owned by a grantor or 
another person consists of an undivided fractional interest in the 
trust, or of an interest represented by a dollar amount, a pro rata 
share of each item of income, deduction, and credit is normally 
allocated to the portion. Thus, where the portion owned consists of an 
interest in or a right to an amount of corpus only, a fraction of each 
item (including items allocated to corpus, such as capital gains) is 
attributed to the portion. The numerator of this fraction is the amount 
which is subject to the control of the grantor or other person and the 
denominator is normally the fair market value of the trust corpus at the 
beginning of the taxable year in question. The share not treated as 
owned by the grantor or other person is governed by the provisions of 
subparts A through D. See the last three sentences of paragraph (c) of 
this section for the principles applicable if the portion treated

[[Page 240]]

as owned consists of an interest in part of the ordinary income in 
contrast to an interest in corpus alone.
    (b) If a grantor or another person is treated as the owner of a 
portion of a trust, that portion may or may not include both ordinary 
income and other income allocable to corpus. For example:
    (1) Only ordinary income is included by reason of an interest in or 
a power over ordinary income alone. Thus, if a grantor is treated under 
section 673 as an owner by reason of a reversionary interest in ordinary 
income only, items of income allocable to corpus will not be included in 
the portion he is treated as owning. Similarly, if a grantor or another 
person is treated under sections 674-678 as an owner of a portion by 
reason of a power over ordinary income only, items of income allocable 
to corpus are not included in that portion. (See paragraph (c) of this 
section to determine the treatment of deductions and credits when only 
ordinary income is included in the portion.)
    (2) Only income allocable to corpus is included by reason of an 
interest in or a power over corpus alone, if satisfaction of the 
interest or an exercise of the power will not result in an interest in 
or the exercise of a power over ordinary income which would itself cause 
that income to be included. For example, if a grantor has a reversionary 
interest in a trust which is not such as to require that he be treated 
as an owner under section 673, he may nevertheless be treated as an 
owner under section 677(a)(2) since any income allocable to corpus is 
accumulated for future distribution to him, but items of income included 
in determining ordinary income are not included in the portion he is 
treated as owning. Similarly, he may have a power over corpus which is 
such that he is treated as an owner under section 674 or 676 (a), but 
ordinary income will not be included in the portion he owns, if his 
power can only affect income received after a period of time such that 
he would not be treated as an owner of the income if the power were a 
reversionary interest. (See paragraph (c) of this section to determine 
the treatment of deductions and credits when only income allocated to 
corpus is included in the portion.)
    (3) Both ordinary income and other income allocable to corpus are 
included by reason of an interest in or a power over both ordinary 
income and corpus, or an interest in or a power over corpus alone which 
does not come within the provisions of subparagraph (2) of this 
paragraph. For example, if a grantor is treated under section 673 as the 
owner of a portion of a trust by reason of a reversionary interest in 
corpus, both ordinary income and other income allocable to corpus are 
included in the portion. Further, a grantor includes both ordinary 
income and other income allocable to corpus in the portion he is treated 
as owning if he is treated under section 674 or 676 as an owner because 
of a power over corpus which can affect income received within a period 
such that he would be treated as an owner under section 673 if the power 
were a reversionary interest. Similarly, a grantor or another person 
includes both ordinary income and other income allocable to corpus in 
the portion he is treated as owning if he is treated as an owner under 
section 675 or 678 because of a power over corpus.
    (c) If only income allocable to corpus is included in computing a 
grantor's tax liability, he will take into account in that computation 
only those items of income, deductions, and credit which would not be 
included under subparts A through D in the computation of the tax 
liability of the current income beneficiaries if all distributable net 
income had actually been distributed to those beneficiaries. On the 
other hand, if the grantor or another person is treated as an owner 
solely because of his interest in or power over ordinary income alone, 
he will take into account in computing his tax liability those items 
which would be included in computing the tax liability of a current 
income beneficiary, including expenses allocable to corpus which enter 
into the computation of distributable net income. If the grantor or 
other person is treated as an owner because of his power over or right 
to a dollar amount of ordinary income, he will first take into account a 
portion of those items of income and expense entering into the 
computation of ordinary income under the trust instrument or local law 
sufficient to produce

[[Page 241]]

income of the dollar amount required. There will then be attributable to 
him a pro rata portion of other items entering into the computation of 
distributable net income under subparts A through D, such as expenses 
allocable to corpus, and a pro rata portion of credits of the trust. For 
examples of computations under this paragraph, see paragraph (g) of 
Sec. 1.677(a)-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6989, 34 FR 
742, Jan. 17, 1969]



Sec. 1.671-4  Method of reporting.

    (a) Portion of trust treated as owned by the grantor or another 
person. Except as otherwise provided in paragraph (b) of this section, 
items of income, deduction, and credit attributable to any portion of a 
trust which, under the provisions of subpart E (section 671 and 
following), part I, subchapter J, chapter 1 of the Internal Revenue 
Code, is treated as owned by the grantor or another person are not 
reported by the trust on Form 1041, but are shown on a separate 
statement to be attached to that form. Section 301.7701-4(e)(2) of this 
chapter provides guidance on how these reporting rules apply to an 
environmental remediation trust.
    (b) A trust all of which is treated as owned by one or more grantors 
or other persons--(1) In general. In the case of a trust all of which is 
treated as owned by one or more grantors or other persons, and which is 
not described in paragraph (b)(6) or (7) of this section, the trustee 
may, but is not required to, report by one of the methods described in 
this paragraph (b) rather than by the method described in paragraph (a) 
of this section. A trustee may not report, however, pursuant to 
paragraph (b)(2)(i)(A) of this section unless the grantor or other 
person treated as the owner of the trust provides to the trustee a 
complete Form W-9 or acceptable substitute Form W-9 signed under 
penalties of perjury. See section 3406 and the regulations thereunder 
for the information to include on, and the manner of executing, the Form 
W-9, depending upon the type of reportable payments made.
    (2) A trust all of which is treated as owned by one grantor or by 
one other person--(i) In general. In the case of a trust all of which is 
treated as owned by one grantor or one other person, the trustee 
reporting under this paragraph (b) must either--
    (A) Furnish the name and taxpayer identification number (TIN) of the 
grantor or other person treated as the owner of the trust, and the 
address of the trust, to all payors during the taxable year, and comply 
with the additional requirements described in paragraph (b)(2)(ii) of 
this section; or
    (B) Furnish the name, TIN, and address of the trust to all payors 
during the taxable year, and comply with the additional requirements 
described in paragraph (b)(2)(iii) of this section.
    (ii) Additional obligations of the trustee when name and TIN of the 
grantor or other person treated as the owner of the trust and the 
address of the trust are furnished to payors. (A) Unless the grantor or 
other person treated as the owner of the trust is the trustee or a co-
trustee of the trust, the trustee must furnish the grantor or other 
person treated as the owner of the trust with a statement that--
    (1) Shows all items of income, deduction, and credit of the trust 
for the taxable year;
    (2) Identifies the payor of each item of income;
    (3) Provides the grantor or other person treated as the owner of the 
trust with the information necessary to take the items into account in 
computing the grantor's or other person's taxable income; and
    (4) Informs the grantor or other person treated as the owner of the 
trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (B) The trustee is not required to file any type of return with the 
Internal Revenue Service.
    (iii) Additional obligations of the trustee when name, TIN, and 
address of the trust are furnished to payors--(A) Obligation to file 
Forms 1099. The trustee must file with the Internal Revenue Service the 
appropriate Forms 1099, reporting the income or gross proceeds paid to 
the trust during the taxable year, and showing the trust as the payor 
and the

[[Page 242]]

grantor or other person treated as the owner of the trust as the payee. 
The trustee has the same obligations for filing the appropriate Forms 
1099 as would a payor making reportable payments, except that the 
trustee must report each type of income in the aggregate, and each item 
of gross proceeds separately. See paragraph (b)(5) of this section 
regarding the amounts required to be included on any Forms 1099 filed by 
the trustee.
    (B) Obligation to furnish statement. (1) Unless the grantor or other 
person treated as the owner of the trust is the trustee or a co-trustee 
of the trust, the trustee must also furnish to the grantor or other 
person treated as the owner of the trust a statement that--
    (i) Shows all items of income, deduction, and credit of the trust 
for the taxable year;
    (ii) Provides the grantor or other person treated as the owner of 
the trust with the information necessary to take the items into account 
in computing the grantor's or other person's taxable income; and
    (iii) Informs the grantor or other person treated as the owner of 
the trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (2) By furnishing the statement, the trustee satisfies the 
obligation to furnish statements to recipients with respect to the Forms 
1099 filed by the trustee.
    (iv) Examples. The following examples illustrate the provisions of 
this paragraph (b)(2):

    Example 1. G, a United States citizen, creates an irrevocable trust 
which provides that the ordinary income is to be payable to him for life 
and that on his death the corpus shall be distributed to B, an unrelated 
person. Except for the right to receive income, G retains no right or 
power which would cause him to be treated as an owner under sections 671 
through 679. Under the applicable local law, capital gains must be added 
to corpus. Since G has a right to receive income, he is treated as an 
owner of a portion of the trust under section 677. The tax consequences 
of any items of capital gain of the trust are governed by the provisions 
of subparts A, B, C, and D (section 641 and following), part I, 
subchapter J, chapter 1 of the Internal Revenue Code. Because not all of 
the trust is treated as owned by the grantor or another person, the 
trustee may not report by the methods described in paragraph (b)(2) of 
this section.
    Example 2. (i)(A) On January 2, 1996, G, a United States citizen, 
creates a trust all of which is treated as owned by G. The trustee of 
the trust is T. During the 1996 taxable year the trust has the following 
items of income and gross proceeds:

Interest..........................................................$2,500
Dividends..........................................................3,205
Proceeds from sale of B stock......................................2,000

    (B) The trust has no items of deduction or credit.
    (ii)(A) The payors of the interest paid to the trust are X ($2,000), 
Y ($300), and Z ($200). The payors of the dividends paid to the trust 
are A ($3,200), and D ($5). The payor of the gross proceeds paid to the 
trust is D, a brokerage firm, which held the B stock as the nominee for 
the trust. The B stock was purchased by T for $1,500 on January 3, 1996, 
and sold by T on November 29, 1996. T chooses to report pursuant to 
paragraph (b)(2)(i)(B) of this section, and therefore furnishes the 
name, TIN, and address of the trust to X, Y, Z, A, and D. X, Y, and Z 
each furnish T with a Form 1099-INT showing the trust as the payee. A 
furnishes T with a Form 1099-DIV showing the trust as the payee. D does 
not furnish T with a Form 1099-DIV because D paid a dividend of less 
than $10 to T. D furnishes T with a Form 1099-B showing the trust as the 
payee.
    (B) On or before February 28, 1997, T files a Form 1099-INT with the 
Internal Revenue Service on which T reports interest attributable to G, 
as the owner of the trust, of $2,500; a Form 1099-DIV on which T reports 
dividends attributable to G, as the owner of the trust, of $3,205; and a 
Form 1099-B on which T reports gross proceeds from the sale of B stock 
attributable to G, as the owner of the trust, of $2,000. On or before 
April 15, 1997, T furnishes a statement to G which lists the following 
items of income and information necessary for G to take the items into 
account in computing G's taxable income:

Interest..........................................................$2,500
Dividends..........................................................3,205
Gain from sale of B stock............................................500

    Information regarding sale of B stock:

Proceeds..........................................................$2,000
Basis..............................................................1,500
Date acquired....................................................1/03/96
Date sold.......................................................11/29/96

    (C) T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of

[[Page 243]]

the grantor or other person on the income tax return of the grantor or 
other person.
    (D) T has complied with T's obligations under this section.
    (iii)(A) Same facts as paragraphs (i) and (ii) of this Example 2, 
except that G contributed the B stock to the trust on January 2, 1996. 
On or before April 15, 1997, T furnishes a statement to G which lists 
the following items of income and information necessary for G to take 
the items into account in computing G's taxable income:

Interest $2,500
Dividends 3,205

    Information regarding sale of B stock:
Proceeds..........................................................$2,000
Date sold.......................................................11/29/96
    (B) T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of the grantor or other person on the 
income tax return of the grantor or other person.
    (C) T has complied with T's obligations under this section.
    Example 3. On January 2, 1996, G, a United States citizen, creates a 
trust all of which is treated as owned by G. The trustee of the trust is 
T. The only asset of the trust is an interest in C, a common trust fund 
under section 584(a). T chooses to report pursuant to paragraph 
(b)(2)(i)(B) of this section and therefore furnishes the name, TIN, and 
address of the trust to C. C files a Form 1065 and a Schedule K-1 
(Partner's Share of Income, Credits, Deductions, etc.) showing the name, 
TIN, and address of the trust with the Internal Revenue Service and 
furnishes a copy to T. Because the trust did not receive any amounts 
described in paragraph (b)(5) of this section, T does not file any type 
of return with the Internal Revenue Service. On or before April 15, 
1997, T furnishes G with a statement that shows all items of income, 
deduction, and credit of the trust for the 1996 taxable year. In 
addition, T informs G that any items of income, deduction and credit and 
other information shown on the statement must be included in computing 
the taxable income and credits of the grantor or other person on the 
income tax return of the grantor or other person. T has complied with 
T's obligations under this section.

    (3) A trust all of which is treated as owned by two or more grantors 
or other persons--(i) In general. In the case of a trust all of which is 
treated as owned by two or more grantors or other persons, the trustee 
must furnish the name, TIN, and address of the trust to all payors for 
the taxable year, and comply with the additional requirements described 
in paragraph (b)(3)(ii) of this section.
    (ii) Additional obligations of trustee--(A) Obligation to file Forms 
1099. The trustee must file with the Internal Revenue Service the 
appropriate Forms 1099, reporting the items of income paid to the trust 
by all payors during the taxable year attributable to the portion of the 
trust treated as owned by each grantor or other person, and showing the 
trust as the payor and each grantor or other person treated as an owner 
of the trust as the payee. The trustee has the same obligations for 
filing the appropriate Forms 1099 as would a payor making reportable 
payments, except that the trustee must report each type of income in the 
aggregate, and each item of gross proceeds separately. See paragraph 
(b)(5) of this section regarding the amounts required to be included on 
any Forms 1099 filed by the trustee.
    (B) Obligation to furnish statement. (1) The trustee must also 
furnish to each grantor or other person treated as an owner of the trust 
a statement that--
    (i) Shows all items of income, deduction, and credit of the trust 
for the taxable year attributable to the portion of the trust treated as 
owned by the grantor or other person;
    (ii) Provides the grantor or other person treated as an owner of the 
trust with the information necessary to take the items into account in 
computing the grantor's or other person's taxable income; and
    (iii) Informs the grantor or other person treated as the owner of 
the trust that the items of income, deduction and credit and other 
information shown on the statement must be included in computing the 
taxable income and credits of the grantor or other person on the income 
tax return of the grantor or other person.
    (2) Except for the requirements pursuant to section 3406 and the 
regulations thereunder, by furnishing the statement, the trustee 
satisfies the obligation to furnish statements to recipients with 
respect to the Forms 1099 filed by the trustee.
    (4) Persons treated as payors--(i) In general. For purposes of this 
section, the term payor means any person who is required by any 
provision of the Internal Revenue Code and the regulations thereunder to 
make any type of

[[Page 244]]

information return (including Form 1099 or Schedule K-1) with respect to 
the trust for the taxable year, including persons who make payments to 
the trust or who collect (or otherwise act as middlemen with respect to) 
payments on behalf of the trust.
    (ii) Application to brokers and customers. For purposes of this 
section, a broker, within the meaning of section 6045, is considered a 
payor. A customer, within the meaning of section 6045, is considered a 
payee.
    (5) Amounts required to be included on Forms 1099 filed by the 
trustee--(i) In general. The amounts that must be included on any Forms 
1099 required to be filed by the trustee pursuant to this section do not 
include any amounts that are reportable by the payor on an information 
return other than Form 1099. For example, in the case of a trust which 
owns an interest in a partnership, the trust's distributive share of the 
income and gain of the partnership is not includible on any Forms 1099 
filed by the trustee pursuant to this section because the distributive 
share is reportable by the partnership on Schedule K-1.
    (ii) Example. The following example illustrates the provisions of 
this paragraph (b)(5):

    Example. (i)(A) On January 2, 1996, G, a United States citizen, 
creates a trust all of which is treated as owned by G. The trustee of 
the trust is T. The assets of the trust during the 1996 taxable year are 
shares of stock in X, an S corporation, a limited partnership interest 
in P, shares of stock in M, and shares of stock in N. T chooses to 
report pursuant to paragraph (b)(2)(i)(B) of this section and therefore 
furnishes the name, TIN, and address of the trust to X, P, M, and N. M 
furnishes T with a Form 1099-DIV showing the trust as the payee. N does 
not furnish T with a Form 1099-DIV because N paid a dividend of less 
than $10 to T. X and P furnish T with Schedule K-1 (Shareholder's Share 
of Income, Credits, Deductions, etc.) and Schedule K-1 (Partner's Share 
of Income, Credits, Deductions, etc.), respectively, showing the trust's 
name, TIN, and address.
    (B) For the 1996 taxable year the trust has the following items of 
income and deduction:

Dividends paid by M . . . . . . . . . . . $12
Dividends paid by N . . . . . . . . . . . 6
Administrative expense . . . . . . . . . $20

    Items reported by X on Schedule K-1 attributable to trust's shares 
of stock in X:

Interest . . . . . . . . . . . . . . . . . . $20
Dividends . . . . . . . . . . . . . . . . . 35

    Items reported by P on Schedule K-1 attributable to trust's limited 
partnership interest in P:

Ordinary income . . . . . . . . . . $300

    (ii)(A) On or before February 28, 1997, T files with the Internal 
Revenue Service a Form 1099-DIV on which T reports dividends 
attributable to G as the owner of the trust in the amount of $18. T does 
not file any other returns.
    (B) T has complied with T's obligation under paragraph 
(b)(2)(iii)(A) of this section to file the appropriate Forms 1099.

    (6) Trusts that cannot report under this paragraph (b). The 
following trusts cannot use the methods of reporting described in this 
paragraph (b)--
    (i) A common trust fund as defined in section 584(a);
    (ii) A trust that has its situs or any of its assets located outside 
the United States;
    (iii) A trust that is a qualified subchapter S trust as defined in 
section 1361(d)(3);
    (iv) A trust all of which is treated as owned by one grantor or one 
other person whose taxable year is a fiscal year;
    (v) A trust all of which is treated as owned by one grantor or one 
other person who is not a United States person; or
    (vi) A trust all of which is treated as owned by two or more 
grantors or other persons, one of whom is not a United States person.
    (7) Grantors or other persons who are treated as owners of the trust 
and are exempt recipients for information reporting purposes--(i) Trust 
treated as owned by one grantor or one other person. The trustee of a 
trust all of which is treated as owned by one grantor or one other 
person may not report pursuant to this paragraph (b) if the grantor or 
other person is an exempt recipient for information reporting purposes.
    (ii) Trust treated as owned by two or more grantors or other 
persons. The trustee of a trust, all of which is treated as owned by two 
or more grantors or other persons, may not report pursuant to this 
paragraph (b) if one or more grantors or other persons treated as owners 
are exempt recipients for information reporting purposes unless--
    (A) At least one grantor or one other person who is treated as an 
owner of

[[Page 245]]

the trust is a person who is not an exempt recipient for information 
reporting purposes; and
    (B) The trustee reports without regard to whether any of the 
grantors or other persons treated as owners of the trust are exempt 
recipients for information reporting purposes.
    (8) Husband and wife who make a single return jointly. A trust all 
of which is treated as owned by a husband and wife who make a single 
return jointly of income taxes for the taxable year under section 6013 
is considered to be owned by one grantor for purposes of this paragraph 
(b).
    (c) Due date for Forms 1099 required to be filed by trustee. The due 
date for any Forms 1099 required to be filed with the Internal Revenue 
Service by a trustee pursuant to this section is the due date otherwise 
in effect for filing Forms 1099.
    (d) Due date and other requirements with respect to statement 
required to be furnished by trustee. The due date for the statement 
required to be furnished by a trustee to the grantor or other person 
treated as an owner of the trust pursuant to this section is the date 
specified by section 6034A(a). The trustee must maintain in its records 
a copy of the statement furnished to the grantor or other person treated 
as an owner of the trust for a period of three years from the due date 
for furnishing such statement specified in this paragraph (d).
    (e) Backup withholding requirements--(1) Trustee reporting under 
paragraph (b)(2)(i)(A) of this section. In order for the trustee to be 
able to report pursuant to paragraph (b)(2)(i)(A) of this section and to 
furnish to all payors the name and TIN of the grantor or other person 
treated as the owner of the trust, the grantor or other person must 
provide a complete Form W-9 to the trustee in the manner provided in 
paragraph (b)(1) of this section, and the trustee must give the name and 
TIN shown on that Form W-9 to all payors. In addition, if the Form W-9 
indicates that the grantor or other person is subject to backup 
withholding, the trustee must notify all payors of reportable interest 
and dividend payments of the requirement to backup withhold. If the Form 
W-9 indicates that the grantor or other person is not subject to backup 
withholding, the trustee does not have to notify the payors that backup 
withholding is not required. The trustee should not give the Form W-9, 
or a copy thereof, to a payor because the Form W-9 contains the address 
of the grantor or other person and paragraph (b)(2)(i)(A) of this 
section requires the trustee to furnish the address of the trust to all 
payors and not the address of the grantor or other person. The trustee 
acts as the agent of the grantor or other person for purposes of 
furnishing to the payors the information required by this paragraph 
(e)(1). Thus, a payor may rely on the name and TIN provided to the payor 
by the trustee, and, if given, on the trustee's statement that the 
grantor is subject to backup withholding.
    (2) Other backup withholding requirements. Whether a trustee is 
treated as a payor for purposes of backup withholding is determined 
pursuant to section 3406 and the regulations thereunder.
    (f) Penalties for failure to file a correct Form 1099 or furnish a 
correct statement. A trustee who fails to file a correct Form 1099 or to 
furnish a correct statement to a grantor or other person treated as an 
owner of the trust as required by paragraph (b) of this section is 
subject to the penalties provided by sections 6721 and 6722 and the 
regulations thereunder.
    (g) Changing reporting methods--(1) Changing from reporting by 
filing Form 1041 to a method described in paragraph (b) of this section. 
If the trustee has filed a Form 1041 for any taxable year ending before 
January 1, 1996 (and has not filed a final Form 1041 pursuant to 
Sec. 1.671-4(b)(3) (as contained in the 26 CFR part 1 edition revised as 
of April 1, 1995)), or files a Form 1041 for any taxable year 
thereafter, the trustee must file a final Form 1041 for the taxable year 
which ends after January 1, 1995, and which immediately precedes the 
first taxable year for which the trustee reports pursuant to paragraph 
(b) of this section, on the front of which form the trustee must write: 
``Pursuant to Sec. 1.671-4(g), this is the final Form 1041 for this 
grantor trust.''.
    (2) Changing from reporting by a method described in paragraph (b) 
of this section to the filing of a Form 1041. The

[[Page 246]]

trustee of a trust who reported pursuant to paragraph (b) of this 
section for a taxable year may report pursuant to paragraph (a) of this 
section for subsequent taxable years. If the trustee reported pursuant 
to paragraph (b)(2)(i)(A) of this section, and therefore furnished the 
name and TIN of the grantor to all payors, the trustee must furnish the 
name, TIN, and address of the trust to all payors for such subsequent 
taxable years. If the trustee reported pursuant to paragraph 
(b)(2)(i)(B) or (b)(3)(i) of this section, and therefore furnished the 
name and TIN of the trust to all payors, the trustee must indicate on 
each Form 1096 (Annual Summary and Transmittal of U.S. Information 
Returns) that it files (or appropriately on magnetic media) for the 
final taxable year for which the trustee so reports that it is the final 
return of the trust.
    (3) Changing between methods described in paragraph (b) of this 
section--(i) Changing from furnishing the TIN of the grantor to 
furnishing the TIN of the trust. The trustee of a trust who reported 
pursuant to paragraph (b)(2)(i)(A) of this section for a taxable year, 
and therefore furnished the name and TIN of the grantor to all payors, 
may report pursuant to paragraph (b)(2)(i)(B) of this section, and 
furnish the name and TIN of the trust to all payors, for subsequent 
taxable years.
    (ii) Changing from furnishing the TIN of the trust to furnishing the 
TIN of the grantor. The trustee of a trust who reported pursuant to 
paragraph (b)(2)(i)(B) of this section for a taxable year, and therefore 
furnished the name and TIN of the trust to all payors, may report 
pursuant to paragraph (b)(2)(i)(A) of this section, and furnish the name 
and TIN of the grantor to all payors, for subsequent taxable years. The 
trustee, however, must indicate on each Form 1096 (Annual Summary and 
Transmittal of U.S. Information Returns) that it files (or appropriately 
on magnetic media) for the final taxable year for which the trustee 
reports pursuant to paragraph (b)(2)(i)(B) of this section that it is 
the final return of the trust.
    (4) Example. The following example illustrates the provisions of 
paragraph (g) of this section:

    Example. (i) On January 3, 1994, G, a United States citizen, creates 
a trust all of which is treated as owned by G. The trustee of the trust 
is T. On or before April 17, 1995, T files with the Internal Revenue 
Service a Form 1041 with an attached statement for the 1994 taxable year 
showing the items of income, deduction, and credit of the trust. On or 
before April 15, 1996, T files with the Internal Revenue Service a Form 
1041 with an attached statement for the 1995 taxable year showing the 
items of income, deduction, and credit of the trust. On the Form 1041, T 
states that ``pursuant to Sec. 1.671-4(g), this is the final Form 1041 
for this grantor trust.'' T may report pursuant to paragraph (b) of this 
section for the 1996 taxable year.
    (ii) T reports pursuant to paragraph (b)(2)(i)(B) of this section, 
and therefore furnishes the name, TIN, and address of the trust to all 
payors, for the 1996 and 1997 taxable years. T chooses to report 
pursuant to paragraph (a) of this section for the 1998 taxable year. On 
each Form 1096 (Annual Summary and Transmittal of U.S. Information 
Returns) which T files for the 1997 taxable year (or appropriately on 
magnetic media), T indicates that it is the trust's final return. On or 
before April 15, 1999, T files with the Internal Revenue Service a Form 
1041 with an attached statement showing the items of income, deduction, 
and credit of the trust. On the Form 1041, T uses the same TIN which T 
used on the Forms 1041 and Forms 1099 it filed for previous taxable 
years. T has complied with T's obligations under paragraph (g)(2) of 
this section.

    (h) Effective date and transition rule--(1) Effective date. The 
trustee of a trust any portion of which is treated as owned by one or 
more grantors or other persons must report pursuant to this section for 
taxable years beginning on or after January 1, 1996.
    (2) Transition rule. For taxable years beginning prior to January 1, 
1996, the Internal Revenue Service will not challenge the manner of 
reporting of--
    (i) A trustee of a trust all of which is treated as owned by one or 
more grantors or other persons who did not report in accordance with 
Sec. 1.671-4(a) (as contained in the 26 CFR part 1 edition revised as of 
April 1, 1995) as in effect for taxable years beginning prior to January 
1, 1996, but did report in a manner substantially similar to one of the 
reporting methods described in paragraph (b) of this section; or
    (ii) A trustee of two or more trusts all of which are treated as 
owned by one or more grantors or other persons who filed a single Form 
1041 for all of

[[Page 247]]

the trusts, rather than a separate Form 1041 for each trust, provided 
that the items of income, deduction, and credit of each trust were shown 
on a statement attached to the single Form 1041.
    (i) Cross-reference. For rules relating to employer identification 
numbers, and to the obligation of a payor of income or proceeds to the 
trust to furnish to the payee a statement to recipient, see 
Sec. 301.6109-1(a)(2) of this chapter.

[T.D. 8633, 60 FR 66087, Dec. 21, 1995, as amended by T.D. 8668, 61 FR 
19191, May 1, 1996]



Sec. 1.672(a)-1   Definition of adverse party.

    (a) Under section 672(a) an adverse party is defined as any person 
having a substantial beneficial interest in a trust which would be 
adversely affected by the exercise or nonexercise of a power which he 
possesses respecting the trust. A trustee is not an adverse party merely 
because of his interest as trustee. A person having a general power of 
appointment over the trust property is deemed to have a beneficial 
interest in the trust. An interest is a substantial interest if its 
value in relation to the total value of the property subject to the 
power is not insignificant.
    (b) Ordinarily, a beneficiary will be an adverse party, but if his 
right to share in the income or corpus of a trust is limited to only a 
part, he may be an adverse party only as to that part. Thus, if A, B, C, 
and D are equal income beneficiaries of a trust and the grantor can 
revoke with A's consent, the grantor is treated as the owner of a 
portion which represents three-fourths of the trust; and items of 
income, deduction, and credit attributable to that portion are included 
in determining the tax of the grantor.
    (c) The interest of an ordinary income beneficiary of a trust may or 
may not be adverse with respect to the exercise of a power over corpus. 
Thus, if the income of a trust is payable to A for life, with a power 
(which is not a general power of appointment) in A to appoint the corpus 
to the grantor either during his life or by will, A's interest is 
adverse to the return of the corpus to the grantor during A's life, but 
is not adverse to a return of the corpus after A's death. In other 
words, A's interest is adverse as to ordinary income but is not adverse 
as to income allocable to corpus. Therefore, assuming no other relevant 
facts exist, the grantor would not be taxable on the ordinary income of 
the trust under section 674, 676, or 677, but would be taxable under 
section 677 on income allocable to corpus (such as capital gains), since 
it may in the discretion of a nonadverse party be accumulated for future 
distribution to the grantor. Similarly, the interest of a contingent 
income beneficiary is adverse to a return of corpus to the grantor 
before the termination of his interest but not to a return of corpus 
after the termination of his interest.
    (d) The interest of a remainderman is adverse to the exercise of any 
power over the corpus of a trust, but not to the exercise of a power 
over any income interest preceding his remainder. For example, if the 
grantor creates a trust which provides for income to be distributed to A 
for 10 years and then for the corpus to go to X if he is then living, a 
power exercisable by X to revest corpus in the grantor is a power 
exercisable by an adverse party; however, a power exercisable by X to 
distribute part or all of the ordinary income to the grantor may be a 
power exercisable by a nonadverse party (which would cause the ordinary 
income to be taxed to the grantor).



Sec. 1.672(b)-1   Nonadverse party.

    A nonadverse party is any person who is not an adverse party.



Sec. 1.672(c)-1   Related or subordinate party.

    Section 672(c) defines the term ``related or subordinate party''. 
The term, as used in sections 674(c) and 675(3), means any nonadverse 
party who is the grantor's spouse if living with the grantor; the 
grantor's father, mother, issue, brother or sister; an employee of the 
grantor; a corporation or any employee of a corporation in which the 
stock holdings of the grantor and the trust are significant from the 
viewpoint of voting control; or a subordinate employee of a corporation 
in which the grantor is an executive. For purposes of sections 674(c) 
and 675(3),

[[Page 248]]

these persons are presumed to be subservient to the grantor in respect 
of the exercise or nonexercise of the powers conferred on them unless 
shown not to be subservient by a preponderance of the evidence.



Sec. 1.672(d)-1   Power subject to condition precedent.

    Section 672(d) provides that a person is considered to have a power 
described in subpart E (section 671 and following), part I, subchapter 
J, chapter 1 of the Code, even though the exercise of the power is 
subject to a precedent giving of notice or takes effect only after the 
expiration of a certain period of time. However, although a person may 
be considered to have such a power, the grantor will nevertheless not be 
treated as an owner by reason of the power if its exercise can only 
affect beneficial enjoyment of income received after the expiration of a 
period of time such that, if the power were a reversionary interest, he 
would not be treated as an owner under section 673. See sections 
674(b)(2), 676(b), and the last sentence of section 677(a). Thus, for 
example, if a grantor creates a trust for the benefit of his son and 
retains a power to revoke which takes effect only after the expiration 
of 2 years from the date of exercise, he is treated as an owner from the 
inception of the trust. However, if the grantor retains a power to 
revoke, exercisable at any time, which can only affect the beneficial 
enjoyment of the ordinary income of a trust received after the 
expiration of 10 years commencing with the date of the transfer in 
trust, or after the death of the income beneficiary, the power does not 
cause him to be treated as an owner with respect to ordinary income 
during the first 10 years of the trust or during the income 
beneficiary's life, as the case may be. See section 676(b).



Sec. 1.673(a)-1   Reversionary interests; income payable to beneficiaries other than certain charitable organizations; general rule.

    (a) Under section 673(a), a grantor, in general, is treated as the 
owner of any portion of a trust in which he has a reversionary interest 
in either the corpus or income if, as of the inception of that portion 
of the trust, the grantor's interest will or may reasonably be expected 
to take effect in possession or enjoyment within 10 years commencing 
with the date of transfer of that portion of the trust. However, the 
following types of reversionary interests are excepted from the general 
rule of the preceding sentence:
    (1) A reversionary interest after the death of the income 
beneficiary of a trust (see paragraph (b) of this section); and
    (2) Except in the case of transfers in trust made after April 22, 
1969, a reversionary interest in a charitable trust meeting the 
requirements of section 673(b) (see Sec. 1.673(b)-1).

Even though the duration of the trust may be such that the grantor is 
not treated as its owner under section 673, and therefore is not taxed 
on the ordinary income, he may nevertheless be treated as an owner under 
section 677(a)(2) if he has a reversionary interest in the corpus. In 
the latter case, items of income, deduction, and credit allocable to 
corpus, such as capital gains and losses, will be included in the 
portion he owns. See Sec. 1.671-3 and the regulations under section 677. 
See Sec. 1.673(d)-1 with respect to a postponement of the date specified 
for reacquisition of a reversionary interest.
    (b) Section 673(c) provides that a grantor is not treated as the 
owner of any portion of a trust by reason of section 673 if his 
reversionary interest in the portion is not to take effect in possession 
or enjoyment until the death of the person or persons to whom the income 
of the portion is regardless of the life expectancies of the income 
beneficiaries. If his reversionary interest is to take effect on or 
after the death of an income beneficiary or upon the expiration of a 
specific term of years, whichever is earlier, the grantor is treated as 
the owner if the specific term of years is less than 10 years (but not 
if the term is 10 years or longer).
    (c) Where the grantor's reversionary interest in a portion of a 
trust is to take effect in possession or enjoyment by reason of some 
event other than the expiration of a specific term of years or the death 
of the income beneficiary, the grantor is treated as the owner of the 
portion if the event may reasonably be expected to occur within 10

[[Page 249]]

years from the date of transfer of that portion, but he is not treated 
as the owner under section 673 if the event may not reasonably be 
expected to occur within 10 years from that date. For example, if the 
reversionary interest in any portion of a trust is to take effect on or 
after the death of the grantor (or any person other than the person to 
whom the income is payable) the grantor is treated under section 673 as 
the owner of the portion if the life expectancy of the grantor (or other 
person) is less than 10 years on the date of transfer of the portion, 
but not if the life expectancy is 10 years or longer. If the 
reversionary interest in any portion is to take effect on or after the 
death of the grantor (or any person other than the person to whom the 
income is payable) or upon the expiration of a specific term of years, 
whichever is earlier, the grantor is treated as the owner of the portion 
if on the date of transfer of the portion either the life expectancy of 
the grantor (or other person) or the specific term is less than 10 
years; however, if both the life expectancy and the specific term are 10 
years or longer the grantor is not treated as the owner of the portion 
under section 673. Similarly, if the grantor has a reversionary interest 
in any portion which will take effect at the death of the income 
beneficiary or the grantor, whichever is earlier, the grantor is not 
treated as an owner of the portion unless his life expectancy is less 
than 10 years.
    (d) It is immaterial that a reversionary interest in corpus or 
income is subject to a contingency if the reversionary interest may, 
taking the contingency into consideration, reasonably be expected to 
take effect in possession or enjoyment within 10 years. For example, the 
grantor is taxable where the trust income is to be paid to the grantor's 
son for 3 years, and the corpus is then to be returned to the grantor if 
he survives that period, or to be paid to the grantor's son if he is 
already decreased.
    (e) See section 671 and Secs. 1.671-2 and 1.671-3 for rules for 
treatment of items of income, deduction, and credit when a person is 
treated as the owner of all or only a portion of a trust.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7357, 40 FR 
23742, June 2, 1975]



Sec. 1.673(b)-1   Income payable to charitable beneficiaries before amendment by Tax Reform Act of 1969).

    (a) Pursuant to section 673(b) a grantor is not treated as an owner 
of any portion of a trust under section 673, even though he has a 
reversionary interest which will take effect within 10 years, to the 
extent that, under the terms of the trust, the income of the portion is 
irrevocably payable for a period of at least 2 years (commencing with 
the date of the transfer) to a designated beneficiary of the type 
described in section 170(b)(1)(A).
    (b) Income must be irrevocably payable to a designated beneficiary 
for at least 2 years commencing with the date of the transfer before the 
benefit of section 673(b) will apply. Thus, section 673(b) will not 
apply if income of a trust is irrevocably payable to University A for 1 
year and then to University B for the next year; or if income of a trust 
may be allocated among two or more charitable beneficiaries in the 
discretion of the trustee or any other person. On the other hand, 
section 673(b) will apply if half the income of a trust is irrevocably 
payable to University A and the other half is irrevocably payable to 
University B for two years.
    (c) Section 673(b) applies to the period of 2 years or longer during 
which income is paid to a designated beneficiary of the type described 
in section 170(b)(1)(A) (i), (ii), or (iii), even though the trust term 
is to extend beyond that period. However, the other provisions of 
section 673 apply to the part of the trust term, if any, that extends 
beyond that period. This paragraph may be illustrated by the following 
example:

    Example. G transfers property in trust with the ordinary income 
payable to University C (which qualifies under section 170(b)(1)(A)(ii)) 
for 3 years, and then to his son, B, for 5 years. At the expiration of 
the term the trust reverts to G. G is not taxed under section 673 of the 
trust income payable to University C for the first 3 years because of 
the application of section 673(b). However, he is taxed on income for 
the next 5 years because he has a reversionary interest which will

[[Page 250]]

take effect within 10 years commencing with the date of the transfer. On 
the other hand, if the income were payable to University C for 3 years 
and then to R for 7 years so that the trust corpus would not be returned 
to G within 10 years, G would not be taxable under section 673 on income 
payable to University C and to B during any part of the term.

    (d) This section does not apply to transfers in trust made after 
April 22, 1969.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by TD, 6605, 27 FR 
8097, Aug. 15, 1962; T.D. 7357, 40 FR 23743, June 2, 1975]



Sec. 1.673(c)-1   Reversionary interest after income beneficiary's death.

    The subject matter of section 673(c) is covered in paragraph (b) of 
Sec. 1.673(a)-1.



Sec. 1.673(d)-1   Postponement of date specified for reacquisition.

    Any postponement of the date specified for the reacquisition of 
possession or enjoyment of any reversionary interest is considered a new 
transfer in trust commencing with the date on which the postponement is 
effected and terminating with the date prescribed by the postponement. 
However, the grantor will not be treated as the owner of any portion of 
a trust for any taxable year by reason of the foregoing sentence if he 
would not be so treated in the absence of any postponement. The rules 
contained in this section may be illustrated by the following example:

    Example. G places property in trust for the benefit of his son B. 
Upon the expiration of 12 years or the earlier death of B the property 
is to be paid over to G or his estate. After the expiration of 9 years G 
extends the term of the trust for an additional 2 years. G is considered 
to have made a new transfer in trust for a term of 5 years (the 
remaining 3 years of the original transfer plus the 2-year extension). 
However, he is not treated as the owner of the trust under section 673 
for the first 3 years of the new term because he would not be so treated 
if the term of the trust had not been extended. G is treated as the 
owner of the trust, however, for the remaining 2 years.



Sec. 1.674(a)-1   Power to control beneficial enjoyment; scope of section 674.

    (a) Under section 674, the grantor is treated as the owner of a 
portion of trust if the grantor or a nonadverse party has a power, 
beyond specified limits, to dispose of the beneficial enjoyment of the 
income or corpus, whether the power is a fiduciary power, a power of 
appointment, or any other power. Section 674(a) states in general terms 
that the grantor is treated as the owner in every case in which he or a 
nonadverse party can affect the beneficial enjoyment of a portion of a 
trust, the limitations being set forth as exceptions in subsections (b), 
(c), and (d) of section 674. These exceptions are discussed in detail in 
Secs. 1.674(b)-1 through 1.674(d)--1. Certain limitations applicable to 
section 674 (b), (c), and (d) are set forth in Sec. 1.674(d)-2. Section 
674(b) describes powers which are excepted regardless of who holds them. 
Section 674(c) describes additional powers of trustees which are 
excepted if at least half the trustees are independent, and if the 
grantor is not a trustee. Section 674(d) describes a further power which 
is excepted if it is held by trustees other than the grantor or his 
spouse (if living with the grantor).
    (b) In general terms the grantor is treated as the owner of a 
portion of a trust if he or a nonadverse party or both has a power to 
dispose of the beneficial enjoyment of the corpus or income unless the 
power is one of the following:
    (1) Miscellaneous powers over either ordinary income or corpus. (i) 
A power that can only affect the beneficial enjoyment of income 
(including capital gains) received after a period of time such that the 
grantor would not be treated as an owner under section 673 if the power 
were a reversionary interest (section 674(b)(2));
    (ii) A testamentary power held by anyone (other than a testamentary 
power held by the grantor over accumulated income) (section 674(b)(3));
    (iii) A power to choose between charitable beneficiaries or to 
affect the manner of their enjoyment of a beneficial interest (section 
674(b)(4));

[[Page 251]]

    (iv) A power to allocate receipts and disbursements between income 
and corpus (section 674(b)(8)).
    (2) Powers of distribution primarily affecting only one beneficiary. 
(i) A power to distribute corpus to or for a current income beneficiary, 
if the distribution must be charged against the share of corpus from 
which the beneficiary may receive income (section 674(b)(5)(B));
    (ii) A power to distribute income to or for a current income 
beneficiary or to accumulate it either (a) if accumulated income must 
either be payable to the beneficiary from whom it was withheld or as 
described in paragraph (b)(6) of Sec. 1.674(b)-1 (section 674(b) (6)); 
(b) if the power is to apply income to the support of a dependent of the 
grantor, and the income is not so applied (section 674(b)(1)); or (c) if 
the beneficiary is under 21 or under a legal disability and accumulated 
income is added to corpus (section 674(b)(7)).
    (3) Powers of distribution affecting more than one beneficiary. A 
power to distribute corpus or income to or among one or more 
beneficiaries or to accumulate income, either (i) if the power is held 
by a trustee or trustees other than the grantor, at least half of whom 
are independent (section 674(c)), or (ii) if the power is limited by a 
reasonably definite standard in the trust instrument, and in the case of 
a power over income, if in addition the power is held by a trustee or 
trustees other than the grantor and the grantor's spouse living with the 
grantor (section 674(b)(5)(A) and (d)). (These powers include both 
powers to ``sprinkle'' income or corpus among current beneficiaries, and 
powers to shift income or corpus between current beneficiaries and 
remaindermen; however, certain of the powers described under 
subparagraph (2) of this paragraph can have the latter effect 
incidentally.)
    (c) See section 671 and Secs. 1.671-2 and 1.671-3 for rules for the 
treatment of income, deductions, and credits when a person is treated as 
the owner of all or only a portion of a trust.



Sec. 1.674(b)-1   Excepted powers exercisable by any person.

    (a) Paragraph (b) (1) through (8) of this section sets forth a 
number of powers which may be exercisable by any person without causing 
the grantor to be treated as an owner of a trust under section 674(a). 
Further, with the exception of powers described in paragraph (b)(1) of 
this section, it is immaterial whether these powers are held in the 
capacity of trustee. It makes no difference under section 674(b) that 
the person holding the power is the grantor, or a related or subordinate 
party (with the qualifications noted in paragraph (b) (1) and (3) of 
this section).
    (b) The exceptions referred to in paragraph (a) of this section are 
as follows (see, however, the limitations set forth in Sec. 1.674(d)-2):
    (1) Powers to apply income to support of a dependent. Section 
674(b)(1) provides, in effect, that regardless of the general rule of 
section 674(a), the income of a trust will not be considered as taxable 
to the grantor merely because in the discretion of any person (other 
than a grantor who is not acting as a trustee or cotrustee) it may be 
used for the support of a beneficiary whom the grantor is legally 
obligated to support, except to the extent that it is in fact used for 
that purpose. See section 677(b) and the regulations thereunder.
    (2) Powers affecting beneficial enjoyment only after a period. 
Section 674(b)(2) provides an exception to section 674(a) if the 
exercise of a power can only affect the beneficial enjoyment of the 
income of a trust received after a period of time which is such that a 
grantor would not be treated as an owner under section 673 if the power 
were a reversionary interest. See Secs. 1.673(a)-1 and 1.673(b)-1. For 
example, if a trust created on January 1, 1955, provides for the payment 
of income to the grantor's son, and the grantor reserves the power to 
substitute other beneficiaries of income or corpus in lieu of his son on 
or after January 1, 1965, the grantor is not treated under section 674 
as the owner of the trust with respect to ordinary income received 
before January 1, 1965. But the grantor will be treated as an owner on 
and after that date unless the power is relinquished. If the beginning 
of the period during which the grantor may substitute beneficiaries is 
postponed, the rules set forth in Sec. 1.673(d)-1 are applicable in 
order to determine whether the grantor should be treated as an

[[Page 252]]

owner during the period following the postponement.
    (3) Testamentary powers. Under paragraph (3) of section 674(b) a 
power in any person to control beneficial enjoyment exercisable only by 
will does not cause a grantor to be treated as an owner under section 
674(a). However, this exception does not apply to income accumulated for 
testamentary disposition by the grantor or to income which may be 
accumulated for such distribution in the discretion of the grantor or a 
nonadverse party, or both, without the approval or consent of any 
adverse party. For example, if a trust instrument provides that the 
income is to be accumulated during the grantor's life and that the 
grantor may appoint the accumulated income by will, the grantor is 
treated as the owner of the trust. Moreover, if a trust instrument 
provides that the income is payable to another person for his life, but 
the grantor has a testamentary power of appointment over the remainder, 
and under the trust instrument and local law capital gains are added to 
corpus, the grantor is treated as the owner of a portion of the trust 
and capital gains and losses are included in that portion. (See 
Sec. 1.671-3.)
    (4) Powers to determine beneficial enjoyment of charitable 
beneficiaries. Under paragraph (4) of section 674(b) a power in any 
person to determine the beneficial enjoyment of corpus or income which 
is irrevocably payable (currently or in the future) for purposes 
specified in section 170(c) (relating to definition of charitable 
contributions) will not cause the grantor to be treated as an owner 
under section 674(a). For example, if a grantor creates a trust, the 
income of which is irrevocably payable solely to educational or other 
organizations that qualify under section 170(c), he is not treated as an 
owner under section 674 although he retains the power to allocate the 
income among such organizations.
    (5) Powers to distribute corpus. Paragraph (5) of section 674(b) 
provides an exception to section 674(a) for powers to distribute corpus, 
subject to certain limitations, as follows:
    (i) If the power is limited by a reasonably definite standard which 
is set forth in the trust instrument, it may extend to corpus 
distributions to any beneficiary or beneficiaries or class of 
beneficiaries (whether income beneficiaries or remaindermen) without 
causing the grantor to be treated as an owner under section 674. See 
section 674(b)(5)(A). It is not required that the standard consist of 
the needs and circumstances of the beneficiary. A clearly measurable 
standard under which the holder of a power is legally accountable is 
deemed a reasonably definite standard for this purpose. For instance, a 
power to distribute corpus for the education, support, maintenance, or 
health of the beneficiary; for his reasonable support and comfort; or to 
enable him to maintain his accustomed standard of living; or to meet an 
emergency, would be limited by a reasonably definite standard. However, 
a power to distribute corpus for the pleasure, desire, or happiness of a 
beneficiary is not limited by a reasonably definite standard. The entire 
context of a provision of a trust instrument granting a power must be 
considered in determining whether the power is limited by a reasonably 
definite standard. For example, if a trust instrument provides that the 
determination of the trustee shall be conclusive with respect to the 
exercise or nonexercise of a power, the power is not limited by a 
reasonably definite standard. However, the fact that the governing 
instrument is phrased in discretionary terms is not in itself an 
indication that no reasonably definite standard exists.
    (ii) If the power is not limited by a reasonably definite standard 
set forth in the trust instrument, the exception applies only if 
distributions of corpus may be made solely in favor of current income 
beneficiaries, and any corpus distribution to the current income 
beneficiary must be chargeable against the proportionate part of corpus 
held in trust for payment of income to that beneficiary as if it 
constituted a separate trust (whether or not physically segregated). See 
section 674(b)(5)(B).
    (iii) This subparagraph may be illustrated by the following 
examples:

    Example 1. A trust instrument provides for payment of the income to 
the grantor's two brothers for life, and for payment of the corpus to 
the grantor's nephews in equal shares. The grantor reserves the power to 
distribute

[[Page 253]]

corpus to pay medical expenses that may be incurred by his brothers or 
nephews. The grantor is not treated as an owner by reason of this power 
because section 674(b)(5)(A) excepts a power, exercisable by any person, 
to invade corpus for any beneficiary, including a remainderman, if the 
power is limited by a reasonably definite standard which is set forth in 
the trust instrument. However, if the power were also exercisable in 
favor of a person (for example, a sister) who was not otherwise a 
beneficiary of the trust, section 674(b)(5)(A) would not be applicable.
    Example 2. The facts are the same as in example 1 except that the 
grantor reserves the power to distribute any part of the corpus to his 
brothers or to his nephews for their happiness. The grantor is treated 
as the owner of the trust. Paragraph (5)(A) of section 674(b) is 
inapplicable because the power is not limited by a reasonably definite 
standard. Paragraph (5)(B) is inapplicable because the power to 
distribute corpus permits a distribution of corpus to persons other than 
current income beneficiaries.
    Example 3. A trust instrument provides for payment of the income to 
the grantor's two adult sons in equal shares for 10 years, after which 
the corpus is to be distributed to his grandchildren in equal shares. 
The grantor reserves the power to pay over to each son up to one-half of 
the corpus during the 10-year period, but any such payment shall 
proportionately reduce subsequent income and corpus payments made to the 
son receiving the corpus. Thus, if one-half of the corpus is paid to one 
son, all the income from the remaining half is thereafter payable to the 
other son. The grantor is not treated as an owner under section 674(a) 
by reason of this power because it qualifies under the exception of 
section 674(b)(5)(B).

    (6) Powers to withhold income temporarily. (i) Section 674(b)(6) 
excepts a power which, in general, enables the holder merely to effect a 
postponement in the time when the ordinary income is enjoyed by a 
current income beneficiary. Specifically, there is excepted a power to 
distribute or apply ordinary income to or for a current income 
beneficiary or to accumulate the income, if the accumulated income must 
ultimately be payable either:
    (a) To the beneficiary from whom it was withheld, his estate, or his 
appointees (or persons designated by name, as a class, or otherwise as 
alternate takers in default of appointment) under a power of appointment 
held by the beneficiary which does not exclude from the class of 
possible appointees any person other than the beneficiary, his estate, 
his creditors, or the creditors of his estate (section 674(b)(6)(A));
    (b) To the beneficiary from whom it was withheld, or if he does not 
survive a date of distribution which could reasonably be expected to 
occur within his lifetime, to his appointees (or alternate takers in 
default of appointment) under any power of appointment, general or 
special, or if he has no power of appointment to one or more designated 
alternate takers (other than the grantor of the grantor's estate) whose 
shares have been irrevocably specified in the trust instrument (section 
674(b)(6)(A) and the flush material following); or
    (c) On termination of the trust, or in conjunction with a 
distribution of corpus which is augmented by the accumulated income, to 
the current income beneficiaries in shares which have been irrevocably 
specified in the trust instrument, or if any beneficiary does not 
survive a date of distribution which would reasonably be expected to 
occur within his lifetime, to his appointees (or alternate takers in 
default of appointment) under any power of appointment, general or 
special, or if he has no power of appointment to one or more designated 
alternate takers (other than the grantor or the grantor's estate) whose 
shares have been irrevocably specified in the trust instrument (section 
674(b)(6)(B) and the flush material following).

(In the application of (a) of this subdivision, if the accumulated 
income of a trust is ultimately payable to the estate of the current 
income beneficiary or is ultimately payable to his appointees or takers 
in default of appointment, under a power of the type described in (a) of 
this subdivision, it need not be payable to the beneficiary from whom it 
was withheld under any circumstances. Furthermore, if a trust otherwise 
qualifies for the exception in (a) of this subdivision the trust income 
will not be considered to be taxable to the grantor under section 677 by 
reason of the existence of the power of appointment referred to in (a) 
of this subdivision.) In general, the exception in section 674(b)(6) is 
not applicable if the power is in substance one to shift ordinary income 
from one beneficiary to another. Thus, a power will not qualify for this 
exception if ordinary income

[[Page 254]]

may be distributed to beneficiary A, or may be added to corpus which is 
ultimately payable to beneficiary B, a remainderman who is not a current 
income beneficiary. However, section 674(b)(6)(B), and (c) of this 
subdivision, permit a limited power to shift ordinary income among 
current income beneficiaries, as illustrated in example 1 of this 
subparagraph.
    (ii) The application of section 674(b)(6) may be illustrated by the 
following examples:

    Example 1. A trust instrument provides that the income shall be paid 
in equal shares to the grantor's two adult daughters but the grantor 
reserves the power to withhold from either beneficiary any part of that 
beneficiary's share of income and to add it to the corpus of the trust 
until the younger daughter reaches the age of 30 years. When the younger 
daughter reaches the age of 30, the trust is to terminate and the corpus 
is to be divided equally between the two daughters or their estates. 
Although exercise of this power may permit the shifting of accumulated 
income from one beneficiary to the other (since the corpus with the 
accumulations is to be divided equally) the power is excepted under 
section 674(b)(6)(B) and subdivision (i)(c) of this subparagraph.
    Example 2. The facts are the same as in example 1, except that the 
grantor of the trust reserves the power to distribute accumulated income 
to the beneficiaries in such shares as he chooses. The combined powers 
are not excepted by section 674(b)(6)(B) since income accumulated 
pursuant to the first power is neither required to be payable only in 
conjunction with a corpus distribution nor required to be payable in 
shares specified in the trust instrument. See, however, section 674(c) 
and Sec. 1.674(c)-1 for the effect of such a power if it is exercisable 
only by independent trustees.
    Example 3. A trust provides for payment of income to the grantor's 
adult son with the grantor retaining the power to accumulate the income 
until the grantor's death, when all accumulations are to be paid to the 
son. If the son predeceases the grantor, all accumulations are, at the 
death of the grantor, to be paid to his daughter, or if she is not 
living, to alternate takers (which do not include the grantor's estate) 
in specified shares. The power is excepted under section 674(b)(6)(A) 
since the date of distribution (the date of the grantor's death) may, in 
the usual case, reasonably be expected to occur during the beneficiary's 
(the son's) lifetime. It is not necessary that the accumulations be 
payable to the son's estate or his appointees if he should predecease 
the grantor for this exception to apply.

    (7) Power to withhold income during disability. Section 674(b)(7) 
provides an exception for a power which, in general, will permit 
ordinary income to be withheld during the legal disability of an income 
beneficiary or while he is under 21. Specifically, there is excepted a 
power, exercisable only during the existence of a legal disability of 
any current income beneficiary or the period during which any income 
beneficiary is under the age of 21 years, to distribute or apply 
ordinary income to or for that beneficiary or to accumulate the income 
and add it to corpus. To qualify under this exception it is not 
necessary that the income ultimately be payable to the income 
beneficiary from whom it was withheld, his estate, or his appointees; 
that is, the accumulated income may be added to corpus and ultimately 
distributed to others. For example, the grantor is not treated as an 
owner under section 674 if the income of a trust is payable to his son 
for life, remainder to his grandchildren, although he reserves the power 
to accumulate income and add it to corpus while his son is under 21.
    (8) Powers to allocate between corpus and income. Paragraph (8) of 
section 674(b) provides that a power to allocate receipts and 
disbursements between corpus and income, even though expressed in broad 
language, will not cause the grantor to be treated as an owner under the 
general rule of section 674(a).



Sec. 1.674(c)-1   Excepted powers exercisable only by independent trustees.

    Section 674(c) provides an exception to the general rule of section 
674(a) for certain powers that are exercisable by independent trustees. 
This exception is in addition to those provided for under section 674(b) 
which may be held by any person including an independent trustee. The 
powers to which section 674(c) apply are powers (a) to distribute, 
apportion, or accumulate income to or for a beneficiary or 
beneficiaries, or to, for, or within a class of beneficiaries, or (b) to 
pay out corpus to or for a beneficiary or beneficiaries or to or for a 
class of beneficiaries (whether or not income beneficiaries). In order

[[Page 255]]

for such a power to fall within the exception of section 674(c) it must 
be exercisable solely (without the approval or consent of any other 
person) by a trustee or trustees none of whom is the grantor and no more 
than half of whom are related or subordinate parties who are subservient 
to the wishes of the grantor. (See section 672(c) for definitions of 
these terms.) An example of the application of section 674(c) is a trust 
whose income is payable to the grantor's three adult sons with power in 
an independent trustee to allocate without restriction the amounts of 
income to be paid to each son each year. Such a power does not cause the 
grantor to be treated as the owner of the trust. See however, the 
limitations set forth in Sec. 1.674(d)-2.



Sec. 1.674(d)-1   Excepted powers exercisable by any trustee other than grantor or spouse.

    Section 674(d) provides an additional exception to the general rule 
of section 674(a) for a power to distribute, apportion, or accumulate 
income to or for a beneficiary or beneficiaries or to, for, or within a 
class of beneficiaries, whether or not the conditions of section 674(b) 
(6) or (7) are satisfied, if the power is solely exercisable (without 
the approval or consent of any other person) by a trustee or trustees 
none of whom is the grantor or spouse living with the grantor, and if 
the power is limited by a reasonably definite external standard set 
forth in the trust instrument (see paragraph (b)(5) of Sec. 1.674(b)-1 
with respect to what constitutes a reasonably definite standard). See, 
however, the limitations set forth in Sec. 1.674(d)-2.



Sec. 1.674(d)-2   Limitations on exceptions in section 674 (b), (c), and (d).

    (a) Power to remove trustee. A power in the grantor to remove, 
substitute, or add trustees (other than a power exercisable only upon 
limited conditions which do not exist during the taxable year, such as 
the death or resignation of, or breach of fiduciary duty by, an existing 
trustee) may prevent a trust from qualifying under section 674 (c) or 
(d). For example, if a grantor has an unrestricted power to remove an 
independent trustee and substitute any person including himself as 
trustee, the trust will not qualify under section 674 (c) or (d). On the 
other hand if the grantor's power to remove, substitute, or add trustees 
is limited so that its exercise could not alter the trust in a manner 
that would disqualify it under section 674 (c) or (d), as the case may 
be, the power itself does not disqualify the trust. Thus, for example, a 
power in the grantor to remove or discharge an independent trustee on 
the condition that he substitute another independent trustee will not 
prevent a trust from qualifying under section 674(c).
    (b) Power to add beneficiaries. The exceptions described in section 
674 (b) (5), (6), and (7), (c), and (d), are not applicable if any 
person has a power to add to the beneficiary or beneficiaries or to a 
class of beneficiaries designated to receive the income or corpus, 
except where the action is to provide for after-born or after-adopted 
children. This limitation does not apply to a power held by a 
beneficiary to substitute other beneficiaries to succeed to his interest 
in the trust (so that he would be an adverse party as to the exercise or 
nonexercise of that power). For example, the limitation does not apply 
to a power in a beneficiary of a nonspendthrift trust to assign his 
interest. Nor does the limitation apply to a power held by any person 
which would qualify as an exception under section 674(b)(3) (relating to 
testamentary powers).



Sec. 1.675-1   Administrative powers.

    (a) General rule. Section 675 provides in effect that the grantor is 
treated as the owner of any portion of a trust if under the terms of the 
trust instrument or circumstances attendant on its operation 
administrative control is exercisable primarily for the benefit of the 
grantor rather than the beneficiaries of the trust. If a grantor retains 
a power to amend the administrative provisions of a trust instrument 
which is broad enough to permit an amendment causing the grantor to be 
treated as the owner of a portion of the trust under section 675, he 
will be treated as the owner of the portion from its inception. See 
section 671 and Secs. 1.671-2 and 1.671-3 for rules for treatment of 
items of income, deduction,

[[Page 256]]

and credit when a person is treated as the owner of all or only a 
portion of a trust.
    (b) Prohibited controls. The circumstances which cause 
administrative controls to be considered exercisable primarily for the 
benefit of the grantor are specifically described in paragraphs (1) 
through (4) of section 675 as follows:
    (1) The existence of a power, exercisable by the grantor or a 
nonadverse party, or both, without the approval or consent of any 
adverse party, which enables the grantor or any other person to 
purchase, exchange, or otherwise deal with or dispose of the corpus or 
the income of the trust for less than adequate consideration in money or 
money's worth. Whether the existence of the power itself will constitute 
the holder an adverse party will depend on the particular circumstances.
    (2) The existence of a power exercisable by the grantor or a 
nonadverse party, or both, which enables the grantor to borrow the 
corpus or income of the trust, directly or indirectly, without adequate 
interest or adequate security. However, this paragraph does not apply 
where a trustee (other than the grantor acting alone) is authorized 
under a general lending power to make loans to any person without regard 
to interest or security. A general lending power in the grantor, acting 
alone as trustee, under which he has power to determine interest rates 
and the adequacy of security is not in itself an indication that the 
grantor has power to borrow the corpus or income without adequate 
interest or security.
    (3) The circumstance that the grantor has directly or indirectly 
borrowed the corpus or income of the trust and has not completely repaid 
the loan, including any interest, before the beginning of the taxable 
year. The preceding sentence does not apply to a loan which provides for 
adequate interest and adequate security, if it is made by a trustee 
other than the grantor or a related or subordinate trustee subservient 
to the grantor. See section 672(c) for definition of ``a related or 
subordinate party''.
    (4) The existence of certain powers of administration exercisable in 
a nonfiduciary capacity by any nonadverse party without the approval or 
consent of any person in a fiduciary capacity. The term powers of 
administration means one or more of the following powers:
    (i) A power to vote or direct the voting of stock or other 
securities of a corporation in which the holdings of the grantor and the 
trust are significant from the viewpoint of voting control;
    (ii) A power to control the investment of the trust funds either by 
directing investments or reinvestments, or by vetoing proposed 
investments or reinvestments, to the extent that the trust funds consist 
of stocks or securities of corporations in which the holdings of the 
grantor and the trust are significant from the viewpoint of voting 
control; or
    (iii) A power to reacquire the trust corpus by substituting other 
property of an equivalent value.

If a power is exercisable by a person as trustee, it is presumed that 
the power is exercisable in a fiduciary capacity primarily in the 
interests of the beneficiaries. This presumption may be rebutted only by 
clear and convincing proof that the power is not exercisable primarily 
in the interests of the beneficiaries. If a power is not exercisable by 
a person as trustee, the determination of whether the power is 
exercisable in a fiduciary or a nonfiduciary capacity depends on all the 
terms of the trust and the circumstances surrounding its creation and 
administration.
    (c) Authority of trustee. The mere fact that a power exercisable by 
a trustee is described in broad language does not indicate that the 
trustee is authorized to purchase, exchange, or otherwise deal with or 
dispose of the trust property or income for less than an adequate and 
full consideration in money or money's worth, or is authorized to lend 
the trust property or income to the grantor without adequate interest. 
On the other hand, such authority may be indicated by the actual 
administration of the trust.

[[Page 257]]



Sec. 1.676(a)-1   Power to revest title to portion of trust property in grantor; general rule.

    If a power to revest in the grantor title to any portion of a trust 
is exercisable by the grantor or a nonadverse party, or both, without 
the approval or consent of an adverse party, the grantor is treated as 
the owner of that portion, except as provided in section 676(b) 
(relating to powers affecting beneficial enjoyment of income only after 
the expiration of certain periods of time). If the title to a portion of 
the trust will revest in the grantor upon the exercise of a power by the 
grantor or a nonadverse party, or both, the grantor is treated as the 
owner of that portion regardless of whether the power is a power to 
revoke, to terminate, to alter or amend, or to appoint. See section 671 
and Secs. 1.671-2 and 1.671-3 for rules for treatment of items of 
income, deduction, and credit when a person is treated as the owner of 
all or only a portion of a trust.



Sec. 1.676(b)-1   Powers exercisable only after a period of time.

    Section 676(b) provides an exception to the general rule of section 
676(a) when the exercise of a power can only affect the beneficial 
enjoyment of the income of a trust received after the expiration of a 
period of time which is such that a grantor would not be treated as the 
owner of that portion, except as power were a reversionary interest. See 
Secs. 1.673(a)-1 and 1.673(b)-1. Thus, for example, a grantor is 
excepted from the general rule of section 676(a) with respect to 
ordinary income if exercise of a power to revest corpus in him cannot 
affect the beneficial enjoyment of the income received within 10 years 
after the date of transfer of that portion of the trust. It is 
immaterial for this purpose that the power is vested at the time of the 
transfer. However, the grantor is subject to the general rule of section 
676(a) after the expiration of the period unless the power is 
relinquished. Thus, in the above example, the grantor may be treated as 
the owner and be taxed on all income in the eleventh and succeeding 
years if exercise of the power can affect beneficial enjoyment of income 
received in those years. If the beginning of the period during which the 
grantor may revest is postponed, the rules set forth in Sec. 1.673(d)-1 
are applicable to determine whether the grantor should be treated as an 
owner during the period following the postponement.



Sec. 1.677(a)-1   Income for benefit of grantor; general rule.

    (a)(1) Scope. Section 677 deals with the treatment of the grantor of 
a trust as the owner of a portion of the trust because he has retained 
an interest in the income from that portion. For convenience, 
``grantor'' and ``spouse'' are generally referred to in the masculine 
and feminine genders, respectively, but if the grantor is a woman the 
reference to ``grantor'' is to her and the reference to ``spouse'' is to 
her husband. Section 677 also deals with the treatment of the grantor of 
a trust as the owner of a portion of the trust because the income from 
property transferred in trust after October 9, 1969, is, or may be, 
distributed to his spouse or applied to the payment of premiums on 
policies of insurance on the life of his spouse. However, section 677 
does not apply when the income of a trust is taxable to a grantor's 
spouse under section 71 (relating to alimony and separate maintenance 
payments) or section 682 (relating to income of an estate or trust in 
case of divorce, etc.). See section 671-1(b).
    (2) Cross references. See section 671 and Secs. 1.671-2 and 1.671-3 
for rules for treatment of items of income, deduction, and credit when a 
person is treated as the owner of all or a portion of a trust.
    (b) Income for benefit of grantor or his spouse; general rule--(1) 
Property transferred in trust prior to October 10, 1969. With respect to 
property transferred in trust prior to October 10, 1969, the grantor is 
treated, under section 677, in any taxable year as the owner (whether or 
not he is treated as an owner under section 674) of a portion of a trust 
of which the income for the taxable year or for a period not within the 
exception described in paragraph (e) of this section is, or in the 
discretion of the grantor or a nonadverse party, or both (without the 
approval or consent of any adverse party) may be:
    (i) Distributed to the grantor;

[[Page 258]]

    (ii) Held or accumulated for future distribution to the grantor; or
    (iii) Applied to the payment of premiums on policies of insurance on 
the life of the grantor, except policies of insurance irrevocably 
payable for a charitable purpose specified in section 170(c).
    (2) Property transferred in trust after October 9, 1969. With 
respect to property transferred in trust after October 9, 1969, the 
grantor is treated, under section 677, in any taxable year as the owner 
(whether or not he is treated as an owner under section 674) of a 
portion of a trust of which the income for the taxable year or for a 
period not within the exception described in paragraph (e) of this 
section is, or in the discretion of the grantor, or his spouse, or a 
nonadverse party, or any combination thereof (without the approval or 
consent of any adverse party other than the grantor's spouse) may be:
    (i) Distributed to the grantor or the grantor's spouse;
    (ii) Held or accumulated for future distribution to the grantor or 
the grantor's spouse; or
    (iii) Applied to the payment of premiums on policies of insurance on 
the life of the grantor or the grantor's spouse, except policies of 
insurance irrevocably payable for a charitable purpose specified in 
section 170(c).

With respect to the treatment of a grantor as the owner of a portion of 
a trust solely because its income is, or may be, distributed or held or 
accumulated for future distribution to a beneficiary who is his spouse 
or applied to the payment of premiums for insurance on the spouse's 
life, section 677(a) applies to the income of a trust solely during the 
period of the marriage of the grantor to a beneficiary. In the case of 
divorce or separation, see sections 71 and 682 and the regulations 
thereunder.
    (c) Constructive distribution; cessation of interest. Under section 
677 the grantor is treated as the owner of a portion of a trust if he 
has retained any interest which might, without the approval or consent 
of an adverse party, enable him to have the income from that portion 
distributed to him at some time either actually or constructively 
(subject to the exception described in paragraph (e) of this section). 
In the case of a transfer in trust after October 9, 1969, the grantor is 
also treated as the owner of a portion of a trust if he has granted or 
retained any interest which might, without the approval or consent of an 
adverse party (other than the grantor's spouse), enable his spouse to 
have the income from the portion at some time, whether or not within the 
grantor's lifetime, distributed to the spouse either actually or 
constructively. See paragraph (b)(2) of this section for additional 
rules relating to the income of a trust prior to the grantor's marriage 
to a beneficiary. Constructive distribution to the grantor or to his 
spouse includes payment on behalf of the grantor or his spouse to 
another in obedience to his or her direction and payment of premiums 
upon policies of insurance on the grantor's, or his spouse's, life 
(other than policies of insurance irrevocably payable for charitable 
purposes specified in section 170(c)). If the grantor (in the case of 
property transferred prior to Oct. 10, 1969) or the grantor and his 
spouse (in the case of property transferred after Oct. 9, 1969) are 
divested permanently and completely of every interest described in this 
paragraph, the grantor is not treated as an owner under section 677 
after that divesting. The word ``interest'' as used in this paragraph 
does not include the possibility that the grantor or his spouse might 
receive back from a beneficiary an interest in a trust by inheritance. 
Further, with respect to transfers in trust prior to October 10, 1969, 
the word ``interest'' does not include the possibility that the grantor 
might receive back from a beneficiary an interest in a trust as a 
surviving spouse under a statutory right of election or a similar right.
    (d) Discharge of legal obligation of grantor or his spouse. Under 
section 677 a grantor is, in general, treated as the owner of a portion 
of a trust whose income is, or in the discretion of the grantor or a 
nonadverse party, or both, may be applied in discharge of a legal 
obligation of the grantor (or his spouse in the case of property 
transferred in trust by the grantor after October 9, 1969). However, see 
Sec. 1.677(b)-1 for special rules for trusts whose income may not be 
applied for the discharge of any

[[Page 259]]

legal obligation of the grantor or the grantor's spouse other than the 
support or maintenance of a beneficiary (other than the grantor's 
spouse) whom the grantor or grantor's spouse is legally obligated to 
support. See Sec. 301.7701-4(e) of this chapter for rules on the 
classification of and application of section 677 to an environmental 
remediation trust.
    (e) Exception for certain discretionary rights affecting income. The 
last sentence of section 677(a) provides that a grantor shall not be 
treated as the owner when a discretionary right can only affect the 
beneficial enjoyment of the income of a trust received after a period of 
time during which a grantor would not be treated as an owner under 
section 673 if the power were a reversionary interest. See 
Secs. 1.673(a)-1 and 1.673(b)-1. For example, if the ordinary income of 
a trust is payable to B for 10 years and then in the grantor's 
discretion income or corpus may be paid to B or to the grantor (or his 
spouse in the case of property transferred in trust by the grantor after 
October 9, 1969), the grantor is not treated as an owner with respect to 
the ordinary income under section 677 during the first 10 years. He will 
be treated as an owner under section 677 after the expiration of the 10-
year period unless the power is relinquished. If the beginning of the 
period during which the grantor may substitute beneficiaries is 
postponed, the rules set forth in Sec. 1.673(d)-1 are applicable in 
determining whether the grantor should be treated as an owner during the 
period following the postponement.
    (f) Accumulation of income. If income is accumulated in any taxable 
year for future distribution to the grantor (or his spouse in the case 
of property transferred in trust by the grantor after Oct. 9, 1969), 
section 677(a)(2) treats the grantor as an owner for that taxable year. 
The exception set forth in the last sentence of section 677(a) does not 
apply merely because the grantor (or his spouse in the case of property 
transferred in trust by the grantor after Oct. 9, 1969) must await the 
expiration of a period of time before he or she can receive or exercise 
discretion over previously accumulated income of the trust, even though 
the period is such that the grantor would not be treated as an owner 
under section 673 if a reversionary interest were involved. Thus, if 
income (including capital gains) of a trust is to be accumulated for 10 
years and then will be, or at the discretion of the grantor, or his 
spouse in the case of property transferred in trust after October 9, 
1969, or a nonadverse party, may be, distributed to the grantor (or his 
spouse in the case of property transferred in trust after Oct. 9, 1969), 
the grantor is treated as the owner of the trust from its inception. If 
income attributable to transfers after October 9, 1969 is accumulated in 
any taxable year during the grantor's lifetime for future distribution 
to his spouse, section 677(a)(2) treats the grantor as an owner for that 
taxable year even though his spouse may not receive or exercise 
discretion over such income prior to the grantor's death.
    (g) Examples. The application of section 677(a) may be illustrated 
by the following examples:

    Example 1. G creates an irrevocable trust which provides that the 
ordinary income is to be payable to him for life and that on his death 
the corpus shall be distributed to B, an unrelated person. Except for 
the right to receive income, G retains no right or power which would 
cause him to be treated as an owner under sections 671 through 677. 
Under the applicable local law capital gains must be applied to corpus. 
During the taxable year 1970 the trust has the following items of gross 
income and deductions:

Dividends.........................................................$5,000
Capital gain.......................................................1,000
Expenses allocable to income.........................................200
Expenses allocable to corpus.........................................100

Since G has a right to receive income he is treated as an owner of a 
portion of the trust under section 677. Accordingly, he should include 
the $5,000 of dividends, $200 income expense, and $100 corpus expense in 
the computation of his taxable income for 1970. He should not include 
the $1,000 capital gain since that is not attributable to the portion of 
the trust that he owns. See Sec. 1.671-3(b). The tax consequences of the 
capital gain are governed by the provisions of subparts A, B, C, and D 
(section 641 and following), part I, subchapter J, chapter 1 of the 
Code. Had the trust sustained a capital loss in any amount the loss 
would likewise not be included in the computation of G's taxable income, 
but would also be governed by the provisions of such subparts.
    Example 2. G creates a trust which provides that the ordinary income 
is payable to his

[[Page 260]]

adult son. Ten years and one day from the date of transfer or on the 
death of his son, whichever is earlier, corpus is to revert to G. In 
addition, G retains a discretionary right to receive $5,000 of ordinary 
income each year. (Absent the exercise of this right all the ordinary 
income is to be distributed to his son.) G retained no other right or 
power which would cause him to be treated as an owner under subpart E 
(section 671 and following). Under the terms of the trust instrument and 
applicable local law capital gains must be applied to corpus. During the 
taxable year 1970 the trust had the following items of income and 
deductions:

Dividends........................................................$10,000
Capital gain.......................................................2,000
Expenses allocable to income.........................................400
Expenses allocable to corpus.........................................200

Since the capital gain is held or accumulated for future distributions 
to G, he is treated under section 677(a)(2) as an owner of a portion of 
the trust to which the gain is attributable. See Sec. 1.671-3(b).
    Therefore, he must include the capital gain in the computation of 
his taxable income. (Had the trust sustained a capital loss in any 
amount, G would likewise include that loss in the computation of his 
taxable income.) In addition, because of G's discretionary right 
(whether exercised or not) he is treated as the owner of a portion of 
the trust which will permit a distribution of income to him of $5,000. 
Accordingly, G includes dividends of $5,208.33 and income expenses of 
$208.33 in computing his taxable income, determined in the following 
manner:

Total dividends...........................................    $10,000.00
Less: Expenses allocable to income........................        400.00
                                                           -------------
    Distributable income of the trust.....................      9,600.00
                                                           =============
Portion of dividends attributable to G (5,000/9,600 x                   
 $10,000).................................................      5,208.33
Portion of income expenses attributable to G (5,000/9,600               
 x  $400).................................................        208.33
                                                           -------------
    Amount of income subject to discretionary right.......      5,000.00
                                                                        

In accordance with Sec. 1.671-3(c), G also takes into account $104.17 
(5,000/9,600 x $200) of corpus expenses in computing his tax liability. 
The portion of the dividends and expenses of the trust not attributable 
to G are governed by the provisions of subparts A through D.

[T.D. 7148, 36 FR 20749, Oct. 29, 1971, as amended by T.D. 8668, 61 FR 
19191, May 1, 1996]



Sec. 1.677(b)-1   Trusts for support.

    (a) Section 677(b) provides that a grantor is not treated as the 
owner of a trust merely because its income may in the discretion of any 
person other than the grantor (except when he is acting as trustee or 
cotrustee) be applied or distributed for the support or maintenance of a 
beneficiary (other than the grantor's spouse in the case of income from 
property transferred in trust after October 9, 1969), such as the child 
of the grantor, whom the grantor or his spouse is legally obligated to 
support. If income of the current year of the trust is actually so 
applied or distributed the grantor may be treated as the owner of any 
portion of the trust under section 677 to that extent, even though it 
might have been applied or distributed for other purposes. In the case 
of property transferred to a trust before October 10, 1969, for the 
benefit of the grantor's spouse, the grantor may be treated as the owner 
to the extent income of the current year is actually applied for the 
support or maintenance of his spouse.
    (b) If any amount applied or distributed for the support of a 
beneficiary, including the grantor's spouse in the case of property 
transferred in trust before October 10, 1969, whom the grantor is 
legally obligated to support is paid out of corpus or out of income 
other than income of the current year, the grantor is treated as a 
beneficiary of the trust, and the amount applied or distributed is 
considered to be an amount paid within the meaning of section 661(a)(2), 
taxable to the grantor under section 662. Thus, he is subject to the 
other relevant portions of subparts A through D (section 641 and 
following), part I, subchapter J, chapter 1 of the Code. Accordingly, 
the grantor may be taxed on an accumulation distribution or a capital 
gain distribution under subpart D (section 665 and following) of such 
part I. Those provisions are applied on the basis that the grantor is 
the beneficiary.
    (c) For the purpose of determining the items of income, deduction, 
and credit of a trust to be included under this section in computing the 
grantor's tax liability, the income of the trust for the taxable year of 
distribution will be deemed to have been first distributed. For example, 
in the case of a trust reporting on the calendar year basis, a 
distribution made on January 1, 1956, will be deemed to have been made 
out of ordinary income of the trust for the calendar year 1956 to the

[[Page 261]]

extent of the income for that year even though the trust had received no 
income as of January 1, 1956. Thus, if a distribution of $10,000 is made 
on January 1, 1956, for the support of the grantor's dependent, the 
grantor will be treated as the owner of the trust for 1956 to that 
extent. If the trust received dividends of $5,000 and incurred expenses 
of $1,000 during that year but subsequent to January 1, he will take 
into account dividends of $5,000 and expenses of $1,000 in computing his 
tax liability for 1956. In addition, the grantor will be treated as a 
beneficiary of the trust with respect to the $6,000 ($10,000 less 
distributable income of $4,000 (dividends of $5,000 less expenses of 
$1,000)) paid out of corpus or out of other than income of the current 
year. See paragraph (b) of this section.
    (d) The exception provided in section 677(b) relates solely to the 
satisfaction of the grantor's legal obligation to support or maintain a 
beneficiary. Consequently, the general rule of section 677(a) is 
applicable when in the discretion of the grantor or nonadverse parties 
income of a trust may be applied in discharge of a grantor's obligations 
other than his obligation of support or maintenance falling within 
section 677(b). Thus, if the grantor creates a trust the income of which 
may in the discretion of a nonadverse party be applied in the payment of 
the grantor's debts, such as the payment of his rent or other household 
expenses, he is treated as an owner of the trust regardless of whether 
the income is actually so applied.
    (e) The general rule of section 677(a), and not section 677(b), is 
applicable if discretion to apply or distribute income of a trust rests 
solely in the grantor, or in the grantor in conjunction with other 
persons, unless in either case the grantor has such discretion as 
trustee or cotrustee.
    (f) The general rule of section 677(a), and not section 677(b), is 
applicable to the extent that income is required, without any 
discretionary determination, to be applied to the support of a 
beneficiary whom the grantor is legally obligated to support.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7148, 36 FR 
20750, Oct. 29, 1971]



Sec. 1.678(a)-1   Person other than grantor treated as substantial owner; general rule.

    (a) Where a person other than the grantor of a trust has a power 
exercisable solely by himself to vest the corpus or the income of any 
portion of a testamentary or inter vivos trust in himself, he is treated 
under section 678(a) as the owner of that portion, except as provided in 
section 678(b) (involving taxation of the grantor) and section 678(c) 
(involving and obligation of support). The holder of such a power also 
is treated as an owner of the trust even though he has partially 
released or otherwise modified the power so that he can no longer vest 
the corpus or income in himself, if he has retained such control of the 
trust as would, if retained by a grantor, subject the grantor to 
treatment as the owner under sections 671 to 677, inclusive. See section 
671 and Secs. 1.671-2 and 1.671-3 for rules for treatment of items of 
income, deduction, and credit where a person is treated as the owner of 
all or only a portion of a trust.
    (b) Section 678(a) treats a person as an owner of a trust if he has 
a power exercisable solely by himself to apply the income or corpus for 
the satisfaction of his legal obligations, other than an obligation to 
support a dependent (see Sec. 1.678(c)-1 subject to the limitation of 
section 678(b). Section 678 does not apply if the power is not 
exercisable solely by himself. However, see Sec. 1.662(a)-4 for 
principles applicable to income of a trust which, pursuant to the terms 
of the trust instrument, is used to satisfy the obligations of a person 
other than the grantor.



Sec. 1.678(b)-1   If grantor is treated as the owner.

    Section 678(a) does not apply with respect to a power over income, 
as originally granted or thereafter modified, if the grantor of the 
trust is treated as the owner under sections 671 to 677, inclusive.



Sec. 1.678(c)-1   Trusts for support.

    (a) Section 678(a) does not apply to a power which enables the 
holder, in the capacity of trustee or cotrustee, to apply the income of 
the trust to the support or maintenance of a person

[[Page 262]]

whom the holder is obligated to support, except to the extent the income 
is so applied. See paragraphs (a), (b), and (c) of Sec. 1.677(b)-1 for 
applicable principles where any amount is applied for the support or 
maintenance of a person whom the holder is obligated to support.
    (b) The general rule in section 678(a) (and not the exception in 
section 678(c)) is applicable in any case in which the holder of a power 
exercisable solely by himself is able, in any capacity other than that 
of trustee or cotrustee, to apply the income in discharge of his 
obligation of support or maintenance.
    (c) Section 678(c) is concerned with the taxability of income 
subject to a power described in section 678(a). It has no application to 
the taxability of income which is either required to be applied pursuant 
to the terms of the trust instrument or is applied pursuant to a power 
which is not described in section 678(a), the taxability of such income 
being governed by other provisions of the Code. See Sec. 1.662(a)-4.



Sec. 1.678(d)-1   Renunciation of power.

    Section 678(a) does not apply to a power which has been renounced or 
disclaimed within a reasonable time after the holder of the power first 
became aware of its existence.

                              miscellaneous



Sec. 1.681(a)-1   Limitation on charitable contributions deductions of trusts; scope of section 681.

    Under section 681, the unlimited charitable contributions deduction 
otherwise allowable to a trust under section 642(c) is, in general, 
subject to percentage limitations, corresponding to those applicable to 
contributions by an individual under section 170(b)(1) (A) and (B), 
under the following circumstances;
    (a) To the extent that the deduction is allocable to ``unrelated 
business income'';
    (b) For taxable years beginning before January 1, 1970, if the trust 
has engaged in a prohibited transaction;
    (c) For taxable years beginning before January 1, 1970, if income is 
accumulated for a charitable purpose and the accumulation is (1) 
unreasonable, (2) substantially diverted to a noncharitable purpose, or 
(3) invested against the interests of the charitable beneficiaries.

Further, if the circumstance set forth in paragraph (a) or (c) of this 
section is applicable, the deduction is limited to income actually paid 
out for charitable purposes, and is not allowed for income only set 
aside or to be used for those purposes. If the circumstance set forth in 
paragraph (b) of this section is applicable, deductions for 
contributions to the trust may be disallowed. The provisions of section 
681 are discussed in detail in Secs. 1.681(a)-2 through 1.681(c)-1. For 
definition of the term ``income'', see section 643(b) and Sec. 1.643(b)-
1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7428, 41 FR 
34627, Aug. 16, 1976]



Sec. 1.681(a)-2   Limitation on charitable contributions deduction of trusts with trade or business income.

    (a) In general. No charitable contributions deduction is allowable 
to a trust under section 642(c) for any taxable year for amounts 
allocable to the trust's unrelated business income for the taxable year. 
For the purpose of section 681(a) the term unrelated business income of 
a trust means an amount which would be computed as the trust's unrelated 
business taxable income under section 512 and the regulations 
thereunder, if the trust were an organization exempt from tax under 
section 501(a) by reason of section 501(c)(3). For the purpose of the 
computation under section 512, the term unrelated trade or business 
includes a trade or business carried on by a partnership of which a 
trust is a member, as well as one carried on by the trust itself. While 
the charitable contributions deduction under section 642(c) is entirely 
disallowed by section 681(a) for amounts allocable to ``unrelated 
business income'', a partial deduction is nevertheless allowed for such 
amounts by the operation of section 512(b)(11), as illustrated in 
paragraphs (b) and (c) of this section. This partial deduction is 
subject to the percentage limitations applicable to contributions by an 
individual under section 170(b)(1) (A) and (B), and is not allowed for 
amounts set

[[Page 263]]

aside or to be used for charitable purposes but not actually paid out 
during the taxable year. Charitable contributions deductions otherwise 
allowable under section 170, 545(b)(2), or 642(c) for contributions to a 
trust are not disallowed solely because the trust has unrelated business 
income.
    (b) Determination of amounts allocable to unrelated business income. 
In determining the amount for which a charitable contributions deduction 
would otherwise be allowable under section 642(c) which are allocable to 
unrelated business income, and therefore not allowable as a deduction, 
the following steps are taken:
    (1) There is first determined the amount which would be computed as 
the trust's unrelated business taxable income under section 512 and the 
regulations thereunder if the trust were an organization exempt from tax 
under section 501(a) by reason of section 501(c)(3), but without taking 
the charitable contributions deduction allowed under section 512(b)(11).
    (2) The amount for which a charitable contributions deduction would 
otherwise be allowable under section 642(c) is then allocated between 
the amount determined in subparagraph (1) of this paragraph and any 
other income of the trust. Unless the facts clearly indicate to the 
contrary, the allocation to the amount determined in subparagraph (1) of 
this paragraph is made on the basis of the ratio (but not in excess of 
100 percent) of the amount determined in subparagraph (1) of this 
paragraph to the taxable income of the trust, determined without the 
deduction for personal exemption under section 642(b), the charitable 
contributions deduction under section 642(c), or the deduction for 
distributions to beneficiaries under section 661(a).
    (3) The amount for which a charitable contributions deduction would 
otherwise be allowable under section 642(c) which is allocable to 
unrelated business income as determined in subparagraph (2) of this 
paragraph, and therefore not allowable as a deduction, is the amount 
determined in subparagraph (2) of this paragraph reduced by the 
charitable contributions deduction which would be allowed under section 
512(b)(11) if the trust were an organization exempt from tax under 
section 501(a) by reason of section 501(c)(3).
    (c) Examples. (1) The application of this section may be illustrated 
by the following examples, in which it is assumed that the Y charity is 
not a charitable organization qualifying under section 170(b)(1)(A) (see 
subparagraph (2) of this paragraph):

    Example 1. The X trust has income of $50,000. There is included in 
this amount a net profit of $31,000 from the operation of a trade or 
business. The trustee is required to pay half of the trust income to A, 
an individual, and the balance of the trust income to the Y charity, an 
organization described in section 170(c)(2). The trustee pays each 
beneficiary $25,000. Under these facts, the unrelated business income of 
the trust (computed before the charitable contributions deduction which 
would be allowed under section 512(b)(11)) is $30,000 ($31,000 less the 
deduction of $1,000 allowed by section 512(b)(12)). The deduction 
otherwise allowable under section 642(c) is $25,000, the amount paid to 
the Y charity. The portion allocable to the unrelated business income 
(computed as prescribed in paragraph (b)(2) of this section) is $15,000, 
that is, an amount which bears the same ratio to $25,000 as $30,000 
bears to $50,000. The portion allocable to the unrelated business 
income, and therefore disallowed as a deduction, is $15,000 reduced by 
$6,000 (20 percent of $30,000, the charitable contributions deduction 
which would be allowable under section 512(b)(11)), or $9,000.
    Example 2. Assume the same facts as in example 1, except that the 
trustee has discretion as to the portion of the trust income to be paid 
to each beneficiary, and the trustee pays $40,000 to A and $10,000 to 
the Y charity. The deduction otherwise allowable under section 642(c) is 
$10,000. The portion allocable to the unrelated business income computed 
as prescribed in paragraph (b)(2) of this section is $6,000, that is, an 
amount which bears the same ratio to $10,000 as $30,000 bears to 
$50,000. Since this amount does not exceed the charitable contributions 
deduction which would be allowable under section 512(b)(11) ($6,000, 
determined as in example 1), no portion of it is disallowed as a 
deduction.
    Example 3. Assume the same facts as in example 1, except that the 
terms of the trust instrument require the trustee to pay to the Y 
charity the trust income, if any, derived from the trade or business, 
and to pay to A all the trust income derived from other sources. The 
trustee pays $31,000 to the Y charity and $19,000 to A. The deduction 
otherwise allowable under section 642(c) is $31,000. Since the entire 
income from the trade or business is paid to Y charity, the amount 
allocable to the unrelated business

[[Page 264]]

income computed before the charitable contributions deduction under 
section 512(b)(11) is $30,000 ($31,000 less the deduction of $1,000 
allowed by section 512(b)(12)). The amount allocable to the unrelated 
business income and therefore disallowed as a deduction is $24,000 
($30,000 less $6,000).
    Example 4. (i) Under the terms of the trust, the trustee is required 
to pay half of the trust income to A, an individual, for his life, and 
the balance of the trust income to the Y charity, an organization 
described in section 170(c)(2). Capital gains are allocable to corpus 
and upon A's death the trust is to terminate and the corpus is to be 
distributed to the Y charity. The trust has taxable income of $50,000 
computed without any deduction for personal exemption, charitable 
contributions, or distributions. The amount of $50,000 includes $10,000 
capital gains, $30,000 ($31,000 less the $1,000 deduction allowed under 
section 512(b)(12)) unrelated business income (computed before the 
charitable contributions deduction which would be allowed under section 
512(b)(11)) and other income of $9,000. The trustee pays each 
beneficiary $20,000.
    (ii) The deduction otherwise allowable under section 642(c) is 
$30,000 ($20,000 paid to Y charity and $10,000 capital gains allocated 
to corpus and permanently set aside for charitable purposes). The 
portion allocable to the unrelated business income is $15,000, that is, 
an amount which bears the same ratio to $20,000 (the amount paid to Y 
charity) as $30,000 bears to $40,000 ($50,000 less $10,000 capital gains 
allocable to corpus). The portion allocable to the unrelated business 
income, and therefore disallowed as a deduction, is $15,000 reduced by 
$6,000 (the charitable contributions deduction which would be allowable 
under section 512(b)(11)), or $9,000.

    (2) If, in the examples in subparagraph (1) of this paragraph, the Y 
charity were a charitable organization qualifying under section 
170(b)(1)(A), then the deduction allowable under section 512(b)(11) 
would be computed at a rate of 30 percent.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6605, 27 FR 
8097, Aug. 15, 1962]



Sec. 1.681(b)-1   Cross reference.

    For disallowance of certain charitable, etc., deductions otherwise 
allowable under section 642(c), see sections 508(d) and 4948(c)(4). See 
also 26 CFR 1.681(b)-1 and 1.681(c)-1 (rev. as of Apr. 1, 1974) for 
provisions applying before January 1, 1970.

[T.D. 7428, 41 FR 34627, Aug. 16, 1976]



Sec. 1.682(a)-1   Income of trust in case of divorce, etc.

    (a) In general. (1) Section 682(a) provides rules in certain cases 
for determining the taxability of income of trusts as between spouses 
who are divorced, or who are separated under a decree of separate 
maintenance or a written separation agreement. In such cases, the spouse 
actually entitled to receive payments from the trust is considered the 
beneficiary rather than the spouse in discharge of whose obligations the 
payments are made, except to the extent that the payments are specified 
to be for the support of the obligor spouse's minor children in the 
divorce or separate maintenance decree, the separation agreement or the 
governing trust instrument. For convenience, the beneficiary spouse will 
hereafter in this section and in Sec. 1.682(b)-1 be referred to as the 
``wife'' and the obligor spouse from whom she is divorced or legally 
separated as the ``husband''. (See section 7701(a)(17).) Thus, under 
section 682(a) income of a trust:
    (i) Which is paid, credited, or required to be distributed to the 
wife in a taxable year of the wife, and
    (ii) Which, except for the provisions of section 682, would be 
includible in the gross income of her husband,

is includible in her gross income and is not includible in his gross 
income.
    (2) Section 682(a) does not apply in any case to which section 71 
applies. Although section 682(a) and section 71 seemingly cover some of 
the same situations, there are important differences between them. Thus, 
section 682(a) applies, for example, to a trust created before the 
divorce or separation and not in contemplation of it, while section 71 
applies only if the creation of the trust or payments by a previously 
created trust are in discharge of an obligation imposed upon or assumed 
by the husband (or made specific) under the court order or decree 
divorcing or legally separating the husband and wife, or a written 
instrument incident to the divorce status or legal separation status, or 
a written separation agreement. If section 71 applies, it requires 
inclusion in the wife's income of the full amount of periodic payments 
received attributable to property in

[[Page 265]]

trust (whether or not out of trust income), while, if section 71 does 
not apply, section 682(a) requires amounts paid, credited, or required 
to be distributed to her to be included only to the extent they are 
includible in the taxable income of a trust beneficiary under subparts A 
through D (section 641 and following), part I, subchapter J, chapter 1 
of the Code.
    (3) Section 682(a) is designed to produce uniformity as between 
cases in which, without section 682(a), the income of a so-called 
alimony trust would be taxable to the husband because of his continuing 
obligation to support his wife or former wife, and other cases in which 
the income of a so-called alimony trust is taxable to the wife or former 
wife because of the termination of the husband's obligation. 
Furthermore, section 682(a) taxes trust income to the wife in all cases 
in which the husband would otherwise be taxed not only because of the 
discharge of his alimony obligation but also because of his retention of 
control over the trust income or corpus. Section 682(a) applies whether 
the wife is the beneficiary under the terms of the trust instrument or 
is an assignee of a beneficiary.
    (4) The application of section 682(a) may be illustrated by the 
following examples, in which it is assumed that both the husband and 
wife make their income tax returns on a calendar year basis:

    Example 1. Upon the marriage of H and W, H irrevocably transfers 
property in trust to pay the income to W for her life for support, 
maintenance, and all other expenses. Some years later, W obtains a legal 
separation from H under an order of court. W, relying upon the income 
from the trust payable to her, does not ask for any provision for her 
support and the decree recites that since W is adequately provided for 
by the trust, no further provision is being made for her. Under these 
facts, section 682(a), rather than section 71, is applicable. Under the 
provisions of section 682(a), the income of the trust which becomes 
payable to W after the order of separation is includible in her income 
and is deductible by the trust. No part of the income is includible in 
H's income or deductible by him.
    Example 2. H transfers property in trust for the benefit of W, 
retaining the power to revoke the trust at any time. H, however, 
promises that if he revokes the trust he will transfer to W property in 
the value of $100,000. The transfer in trust and the agreement were not 
incident to divorce, but some years later W divorces H. The court decree 
is silent as to alimony and the trust. After the divorce, income of the 
trust which becomes payable to W is taxable to her, and is not taxable 
to H or deductible by him. If H later terminates the trust and transfers 
$100,000 of property to W, the $100,000 is not income to W nor 
deductible by H.

    (b) Alimony trust income designated for support of minor children. 
Section 682(a) does not require the inclusion in the wife's income of 
trust income which the terms of the divorce or separate maintenance 
decree, separation agreement, or trust instrument fix in terms of an 
amount of money or a portion of the income as a sum which is payable for 
the support of minor children of the husband. The portion of the income 
which is payable for the support of the minor children is includible in 
the husband's income. If in such a case trust income fixed in terms of 
an amount of money is to be paid but a lesser amount becomes payable, 
the trust income is considered to be payable for the support of the 
husband's minor children to the extent of the sum which would be payable 
for their support out of the originally specified amount of trust 
income. This rule is similar to that provided in the case of periodic 
payments under section 71. See Sec. 1.71-1.



Sec. 1.682(b)-1  Application of trust rules to alimony payments.

    (a) For the purpose of the application of subparts A through D 
(section 641 and following), part I, subchapter J, chapter 1 of the 
Code, the wife described in section 682 or section 71 who is entitled to 
receive payments attributable to property in trust is considered a 
beneficiary of the trust, whether or not the payments are made for the 
benefit of the husband in discharge of his obligations. A wife treated 
as a beneficiary of a trust under this section is also treated as the 
beneficiary of such trust for purposes of the tax imposed by section 56 
(relating to the minimum tax for tax preferences). For rules relating to 
the treatment of items of tax preference with respect to a beneficiary 
of a trust, see Sec. 1.58-3.
    (b) A periodic payment includible in the wife's gross income under 
section

[[Page 266]]

71 attributable to property in trust is included in full in her gross 
income in her taxable year in which any part is required to be included 
under section 652 or 662. Assume, for example, in a case in which both 
the wife and the trust file income tax returns on the calendar year 
basis, that an annuity of $5,000 is to be paid to the wife by the 
trustee every December 31 (out of trust income if possible and, if not, 
out of corpus) pursuant to the terms of a divorce decree. Of the $5,000 
distributable on December 31, 1954, $4,000 is payable out of income and 
$1,000 out of corpus. The actual distribution is made in 1955. Although 
the periodic payment is received by the wife in 1955, since under 
section 662 the $4,000 income distributable on December 31, 1954, is to 
be included in the wife's income for 1954, the $1,000 payment out of 
corpus is also to be included in her income for 1954.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7564, 43 FR 
40495, Sept. 12, 1978]



Sec. 1.682(c)-1   Definitions.

    For definitions of the terms ``husband'' and ``wife'' as used in 
section 682, see section 7701(a)(17) and the regulations thereunder.



Sec. 1.683-1   Applicability of provisions; general rule.

    Part I (section 641 and following), subchapter J, chapter 1 of the 
Code, applies to estates and trusts and to beneficiaries only with 
respect to taxable years which begin after December 31, 1953, and end 
after August 16, 1954 the date of enactment of the Internal Revenue Code 
of 1954. In the case of an estate or trust, the date on which a trust is 
created or amended or on which an estate commences, and the taxable 
years of beneficiaries, grantors, or decedents concerned are immaterial. 
This provision applies equally to taxable years of normal and of 
abbreviated length.



Sec. 1.683-2   Exceptions.

    (a) In the case of any beneficiary of an estate or trust, sections 
641 through 682 do not apply to any amount paid, credited, or to be 
distributed by an estate or trust in any taxable year of the estate or 
trust which begins before January 1, 1954, or which ends before August 
17, 1954. Whether an amount so paid, credited, or to be distributed is 
to be included in the gross income of a beneficiary is determined with 
reference to the Internal Revenue Code of 1939. Thus, if a trust in its 
fiscal year ending June 30, 1954, distributed its current income to a 
beneficiary on June 30, 1954, the extent to which the distribution is 
includible in the beneficiary's gross income for his taxable year (the 
calendar year 1954) and the character of such income will be determined 
under the Internal Revenue Code of 1939. The Internal Revenue Code of 
1954, however, determines the beneficiary's tax liability for a taxable 
year of the beneficiary to which such Code applies, with respect even to 
gross income of the beneficiary determined under the Internal Revenue 
Code of 1939 in accordance with this paragraph. Accordingly, the 
beneficiary is allowed credits and deductions pursuant to the Internal 
Revenue Code of 1954 for a taxable year governed by the Internal Revenue 
Code of 1954. See subparagraph (ii) of example (1) in paragraph (c) of 
this section.
    (b) For purposes of determining the time of receipt of dividends 
under sections 34 (for purposes of the credit for dividends received on 
or before December 31, 1964) and 116, the dividends paid, credited, or 
to be distributed to a beneficiary are deemed to have been received by 
the beneficiary ratably on the same dates that the dividends were 
received by the estate or trust.
    (c) The application of this section may be illustrated by the 
following examples:

    Example 1. (i) A trust, reporting on the fiscal year basis, receives 
in its taxable year ending November 30, 1954, dividends on December 3, 
1953, and April 3, July 5, and October 4, 1954. It distributes the 
dividends to A, its sole beneficiary (who reports on the calendar year 
basis) on November 30, 1954. Since the trust has received dividends in a 
taxable year ending after July 31, 1954, it will receive a dividend 
credit under section 34 with respect to dividends received which 
otherwise qualify under that section, in this case dividends received on 
October 4, 1954 (i. e., received after July 31, 1954). See section 
7851(a)(1)(C). This credit, however, is reduced to the extent the 
dividends are allocable to the beneficiary as a result of income being 
paid, credited, or required to be distributed

[[Page 267]]

to him. The trust will also be permitted the dividend exclusion under 
section 116, since it received its dividends in a taxable year ending 
after July 31, 1954.
    (ii) A is entitled to the section 34 credit with respect to the 
portion of the October 4, 1954, dividends which is distributed to him 
even though the determination of whether the amount distributed to him 
is includible in his gross income is made under the Internal Revenue 
Code of 1939. The credit allowable to the trust is reduced 
proportionately to the extent A is deemed to have received the October 4 
dividends. A is not entitled to a credit with respect to the dividends 
received by the trust on December 3, 1953, and April 3, and July 5, 
1954, because, although he receives after July 31, 1954, the 
distribution resulting from the trust's receipt of dividends, he is 
deemed to have received the dividends ratably with the trust on dates 
prior to July 31, 1954. In determining the exclusion under section 116 
to which he is entitled, all the dividends received by the trust in 1954 
and distributed to him are aggregated with any other dividends received 
by him in 1954, since he is deemed to have received such dividends in 
1954 and therefore within a taxable year ending after July 31, 1954. He 
is not, however, entitled to the exclusion for the dividends received by 
the trust in December 1953.
    Example 2. (i) A simple trust reports on the basis of a fiscal year 
ending July 31. It receives dividends on October 3, 1953, and January 4, 
April 3, and July 5, 1954. It distributes the dividends to A, its sole 
beneficiary, on September 1, 1954. The trust, receiving dividends in a 
taxable year ending prior to August 17, 1954, is entitled neither to the 
dividend received credit under section 34 nor the dividend exclusion 
under section 116.
    (ii) A (reporting on the calendar year basis) is not entitled to the 
section 34 credit, because, although he receives after July 31, 1954, 
the distribution resulting from the trust's receipt of dividends, he is 
deemed to have received the dividends ratably with the trust, that is, 
on October 3, 1953, and January 4, April 3, and July 5, 1954. He is, 
however, entitled to the section 116 exclusion with respect to the 
dividends received by the trust in 1954 (along with other dividends 
received by him in 1954) and distributed to him, since he is deemed to 
have received such dividends on January 4, April 3, and July 5, 1954, 
each a date in this taxable year ending after July 31, 1954. He is 
entitled to no exclusion for the dividends received by the trust on 
October 3, 1953, since he is deemed to receive the resulting 
distribution on the same date, which falls within a taxable year of his 
which ends before August 1, 1954, although he is required to include the 
October 1953 dividends in his 1954 income. See section 164 of the 
Internal Revenue Code of 1939.
    Example 3. A simple trust on a fiscal year ending July 31, 1954, 
receives dividends August 5 and November 4, 1953. It distributes the 
dividends to A, its sole beneficiary (who is on a calendar year basis), 
on September 1, 1954. Neither the trust nor A is entitled to a credit 
under section 34 or an exclusion under section 116.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6777, 29 FR 
17809, Dec. 16, 1964]



Sec. 1.683-3   Application of the 65-day rule of the Internal Revenue Code of 1939.

    If an amount is paid, credited, or to be distributed in the first 65 
days of the first taxable year of an estate or trust (heretofore subject 
to the provisions of the Internal Revenue Code of 1939) to which the 
Internal Revenue Code of 1954 applies and the amount would be treated, 
if the Internal Revenue Code of 1939 were applicable, as if paid, 
credited, or to be distributed on the last day of the preceding taxable 
year, sections 641 through 682 do not apply to the amount. The amount so 
paid, credited, or to be distributed is taken into account as provided 
in the Internal Revenue Code of 1939. See 26 CFR (1939) 39.162-2 (c) and 
(d) (Regulations 118).

                     Income in Respect of Decedents



Sec. 1.691(a)-1   Income in respect of a decedent.

    (a) Scope of section 691. In general, the regulations under section 
691 cover: (1) The provisions requiring that amounts which are not 
includible in gross income for the decedent's last taxable year or for a 
prior taxable year be included in the gross income of the estate or 
persons receiving such income to the extent that such amounts constitute 
``income in respect of a decedent''; (2) the taxable effect of a 
transfer of the right to such income; (3) the treatment of certain 
deductions and credit in respect of a decedent which are not allowable 
to the decedent for the taxable period ending with his death or for a 
prior taxable year; (4) the allowance to a recipient of income in 
respect of a decedent of a deduction for estate taxes attributable to 
the inclusion of the value of the right to such

[[Page 268]]

income in the decedent's estate; (5) special provisions with respect to 
installment obligations acquired from a decedent and with respect to the 
allowance of a deduction for estate taxes to a surviving annuitant under 
a joint and survivor annuity contract; and (6) special provisions 
relating to installment obligations transmitted at death when prior law 
applied to the transmission.
    (b) General definition. In general, the term income in respect of a 
decedent refers to those amounts to which a decedent was entitled as 
gross income but which were not properly includible in computing his 
taxable income for the taxable year ending with the date of his death or 
for a previous taxable year under the method of accounting employed by 
the decedent. See the regulations under section 451. Thus, the term 
includes:
    (1) All accrued income of a decedent who reported his income by use 
of the cash receipts and disbursements method;
    (2) Income accrued solely by reason of the decedent's death in case 
of a decedent who reports his income by use of an accrual method of 
accounting; and
    (3) Income to which the decedent had a contingent claim at the time 
of his death.

See sections 736 and 753 and the regulations thereunder for ``income in 
respect of a decedent'' in the case of a deceased partner.
    (c) Prior decedent. The term income in respect of a decedent also 
includes the amount of all items of gross income in respect of a prior 
decedent, if (1) the right to receive such amount was acquired by the 
decedent by reason of the death of the prior decedent or by bequest, 
devise, or inheritance from the prior decedent and if (2) the amount of 
gross income in respect of the prior decedent was not properly 
includible in computing the decedent's taxable income for the taxable 
year ending with the date of his death or for a previous taxable year. 
See example 2 of paragraph (b) of Sec. 1.691(a)-2.
    (d) Items excluded from gross income. Section 691 applies only to 
the amount of items of gross income in respect of a decedent, and items 
which are excluded from gross income under subtitle A of the Code are 
not within the provisions of section 691.
    (e) Cross reference. For items deemed to be income in respect of a 
decedent for purposes of the deduction for estate taxes provided by 
section 691(c), see paragraph (c) of Sec. 1.691(c)-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6808, 30 FR 
3435, Mar. 16, 1965]



Sec. 1.691(a)-2   Inclusion in gross income by recipients.

    (a) Under section 691(a)(1), income in respect of a decedent shall 
be included in the gross income, for the taxable year when received, of:
    (1) The estate of the decedent, if the right to receive the amount 
is acquired by the decedent's estate from the decedent;
    (2) The person who, by reason of the death of the decedent, acquires 
the right to receive the amount, if the right to receive the amount is 
not acquired by the decedent's estate from the decedent; or
    (3) The person who acquires from the decedent the right to receive 
the amount by bequest, devise, or inheritance, if the amount is received 
after a distribution by the decedent's estate of such right.

These amounts are included in the income of the estate or of such 
persons when received by them whether or not they report income by use 
of the cash receipts and disbursements methods.
    (b) The application of paragraph (a) of this section may be 
illustrated by the following examples, in each of which it is assumed 
that the decedent kept his books by use of the cash receipts and 
disbursements method.

    Example 1. The decedent was entitled at the date of his death to a 
large salary payment to be made in equal annual installments over five 
years. His estate, after collecting two installments, distributed the 
right to the remaining installment payments to the residuary legatee of 
the estate. The estate must include in its gross income the two 
installments received by it, and the legatee must include in his gross 
income each of the three installments received by him.
    Example 2. A widow acquired, by bequest from her husband, the right 
to receive renewal commissions on life insurance sold by him in his 
lifetime, which commissions were payable over a period of years. The 
widow

[[Page 269]]

died before having received all of such commissions, and her son 
inherited the right to receive the rest of the commissions. The 
commissions received by the widow were includible in her gross income. 
The commissions received by the son were not includible in the widow's 
gross income but must be included in the gross income of the son.
    Example 3. The decedent owned a Series E United States savings bond, 
with his wife as co-owner or beneficiary, but died before the payment of 
such bond. The entire amount of interest accruing on the bond and not 
includible in income by the decedent, not just the amount accruing after 
the death of the decedent, would be treated as income to his wife when 
the bond is paid.
    Example 4. A, prior to his death, acquired 10,000 shares of the 
capital stock of the X Corporation at a cost of $100 per share. During 
his lifetime, A had entered into an agreement with X Corporation whereby 
X Corporation agreed to purchase and the decedent agreed that his 
executor would sell the 10,000 shares of X Corporation stock owned by 
him at the book value of the stock at the date of A's death. Upon A's 
death, the shares are sold by A's executor for $500 a share pursuant to 
the agreement. Since the sale of stock is consummated after A's death, 
there is no income in respect of a decedent with respect to the 
appreciation in value of A's stock to the date of his death. If, in this 
example, A had in fact sold the stock during his lifetime but payment 
had not been received before his death, any gain on the sale would 
constitute income in respect of a decedent when the proceeds were 
received.
    Example 5. (1) A owned and operated an apple orchard. During his 
lifetime, A sold and delivered 1,000 bushels of apples to X, a canning 
factory, but did not receive payment before his death. A also entered 
into negotiations to sell 3,000 bushels of apples to Y, a canning 
factory, but did not complete the sale before his death. After A's 
death, the executor received payment from X. He also completed the sale 
to Y and transferred to Y 1,200 bushels of apples on hand at A's death 
and harvested and transferred an additional 1,800 bushels. The gain from 
the sale of apples by A to X constitutes income in respect of a decedent 
when received. On the other hand, the gain from the sale of apples by 
the executor to Y does not.
    (2) Assume that, instead of the transaction entered into with Y, A 
had disposed of the 1,200 bushels of harvested apples by delivering them 
to Z, a cooperative association, for processing and sale. Each year the 
association commingles the fruit received from all of its members into a 
pool and assigns to each member a percentage interest in the pool based 
on the fruit delivered by him. After the fruit is processed and the 
products are sold, the association distributes the net proceeds from the 
pool to its members in proportion to their interests in the pool. After 
A's death, the association made distributions to the executor with 
respect to A's share of the proceeds from the pool in which A had in 
interest. Under such circumstances, the proceeds from the disposition of 
the 1,200 bushels of apples constitute income in respect of a decedent.



Sec. 1.691(a)-3  Character of gross income.

    (a) The right to receive an amount of income in respect of a 
decedent shall be treated in the hands of the estate, or by the person 
entitled to receive such amount by bequest, devise, or inheritance from 
the decedent or by reason of his death, as if it had been acquired in 
the transaction by which the decedent (or a prior decedent) acquired 
such right, and shall be considered as having the same character it 
would have had if the decedent (or a prior decedent) had lived and 
received such amount. The provisions of section 1014(a), relating to the 
basis of property acquired from a decedent, do not apply to these 
amounts in the hands of the estate and such persons. See section 
1014(c).
    (b) The application of paragraph (a) of this section may be 
illustrated by the following:
    (1) If the income would have been capital gain to the decedent, if 
he had lived and had received it, from the sale of property, held for 
more than 1 year (6 months for taxable years beginning before 1977; 9 
months for taxable years beginning in 1977), the income, when received, 
shall be treated in the hands of the estate or of such person as capital 
gain from the sale of the property, held for more than 1 year (6 months 
for taxable years beginning before 1977; 9 months for taxable years 
beginning in 1977), in the same manner as if such person had held the 
property for the period the decedent held it, and had made the sale.
    (2) If the income is interest on United States obligations which 
were owned by the decedent, such income shall be treated as interest on 
United States obligations in the hands of the person receiving it, for 
the purpose of determining the credit provided by section 35, as if such 
person had owned the obligations with respect to which such interest is 
paid.
    (3) If the amounts received would be subject to special treatment 
under part

[[Page 270]]

I (section 1301 and following), subchapter Q, chapter 1 of the Code, 
relating to income attributable to serveral taxable years, as in effect 
for taxable years beginning before January 1, 1964, if the decedent had 
lived and included such amounts in his gross income, such sections apply 
with respect to the recipient of the income.
    (4) The provisions of sections 632 and 1347, relating to the tax 
attributable to the sale of certain oil or gas property and to certain 
claims against the United States, apply to any amount included in gross 
income, the right to which was obtained by the decedent by a sale or 
claim within the provisions of those sections.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6885, 31 FR 
7803, June 2, 1966; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.691(a)-4   Transfer of right to income in respect of a decedent.

    (a) Section 691(a)(2) provides the rules governing the treatment of 
income in respect of a decedent (or a prior decedent) in the event a 
right to receive such income is transferred by the estate or person 
entitled thereto by bequest, devise, or inheritance, or by reason of the 
death of the decedent. In general, the transferor must include in his 
gross income for the taxable period in which the transfer occurs the 
amount of the consideration, if any, received for the right or the fair 
market value of the right at the time of the transfer, whichever is 
greater. Thus, upon a sale of such right by the estate or person 
entitled to receive it, the fair market value of the right or the amount 
received upon the sale, whichever is greater, is included in the gross 
income of the vendor. Similarly, if such right is disposed of by gift, 
the fair market value of the right at the time of the gift must be 
included in the gross income of the donor. In the case of a satisfaction 
of an installment obligation at other than face value, which is likewise 
considered a transfer under section 691(a)(2), see Sec. 1.691(a)-5.
    (b) If the estate of a decedent or any person transmits the right to 
income in respect of a decedent to another who would be required by 
section 691(a)(1) to include such income when received in his gross 
income, only the transferee will include such income when received in 
his gross income. In this situation, a transfer within the meaning of 
section 691(a)(2) has not occurred. This paragraph may be illustrated by 
the following:
    (1) If a person entitled to income in respect of a decedent dies 
before receiving such income, only his estate or other person entitled 
to such income by bequest, devise, or inheritance from the latter 
decedent, or by reason of the death of the latter decedent, must include 
such amount in gross income when received.
    (2) If a right to income in respect of a decedent is transferred by 
an estate to a specific or residuary legatee, only the specific or 
residuary legatee must include such income in gross income when 
received.
    (3) If a trust to which is bequeathed a right of a decedent to 
certain payments of income terminates and transfers the right to a 
beneficiary, only the beneficiary must include such income in gross 
income when received.

If the transferee described in subparagraphs (1), (2), and (3) of this 
paragraph transfers his right to receive the amounts in the manner 
described in paragraph (a) of this section, the principles contained in 
paragraph (a) are applied to such transfer. On the other hand, if the 
transferee transmits his right in the manner described in this 
paragraph, the principles of this paragraph are again applied to such 
transfer.



Sec. 1.691(a)-5   Installment obligations acquired from decedent.

    (a) Section 691(a)(4) has reference to an installment obligation 
which remains uncollected by a decedent (or a prior decedent) and which 
was originally acquired in a transaction the income from which was 
properly reportable by the decedent on the installment method under 
section 453. Under the provisions of section 691(a)(4), an amount equal 
to the excess of the face value of the obligation over its basis in the 
hands of the decedent (determined under section 453(d)(2) and the 
regulations thereunder) shall be considered an amount of income in 
respect of a decedent and shall be treated as such. The decedent's 
estate (or the person

[[Page 271]]

entitled to receive such income by bequest or inheritance from the 
decedent or by reason of the decedent's death) shall include in its 
gross income when received the same proportion of any payment in 
satisfaction of such obligations as would be returnable as income by the 
decedent if he had lived and received such payment. No gain on account 
of the transmission of such obligations by the decedent's death is 
required to be reported as income in the return of the decedent for the 
year of his death. See Sec. 1.691(e)-1 for special provisions relating 
to the filing of an election to have the provisions of section 691(a)(4) 
apply in the case of installment obligations in respect of which section 
44(d) of the Internal Revenue Code of 1939 (or corresponding provisions 
of prior law) would have applied but for the filing of a bond referred 
to therein.
    (b) If an installment obligation described in paragraph (a) of this 
section is transferred within the meaning of section 691(a)(2) and 
paragraph (a) of Sec. 1.691(a)-4, the entire installment obligation 
transferred shall be considered a right to income in respect of a 
decedent but the amount includible in the gross income of the transferor 
shall be reduced by an amount equal to the basis of the obligation in 
the hands of the decedent (determined under section 453(d)(2) and the 
regulations thereunder) adjusted, however, to take into account the 
receipt of any installment payments after the decedent's death and 
before such transfer. Thus, the amount includible in the gross income of 
the transferor shall be the fair market value of such obligation at the 
time of the transfer or the consideration received for the transfer of 
the installment obligation, whichever is greater, reduced by the basis 
of the obligation as described in the preceding sentence. For purposes 
of this paragraph, the term ``transfer'' in section 691(a)(2) and 
paragraph (a) of Sec. 1.691(a)-4 includes the satisfaction of an 
installment obligation at other than face value.
    (c) The application of this section may be illustrated by the 
following example:

    Example. An heir of a decedent is entitled to collect an installment 
obligation with a face value of $100, a fair market value of $80, and a 
basis in the hands of the decedent of $60. If the heir collects the 
obligation at face value, the excess of the amount collected over the 
basis is considered income in respect of a decedent and includible in 
the gross income of the heir under section 691(a)(1). In this case, the 
amount includible would be $40 ($100 less $60). If the heir collects the 
obligation at $90, an amount other than face value, the entire 
obligation is considered a right to receive income in respect of a 
decedent but the amount ordinarily required to be included in the heir's 
gross income under section 691(a)(2) (namely, the consideration received 
in satisfaction of the installment obligation or its fair market value, 
whichever is greater) shall be reduced by the amount of the basis of the 
obligation in the hands of the decedent. In this case, the amount 
includible would be $30 ($90 less $60).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6808, 30 FR 
3435, Mar. 16, 1965]



Sec. 1.691(b)-1  Allowance of deductions and credit in respect to decedents.

    (a) Under section 691(b) the expenses, interest, and taxes described 
in sections 162, 163, 164, and 212 for which the decedent (or a prior 
decedent) was liable, which were not properly allowable as a deduction 
in his last taxable year or any prior taxable year, are allowed when 
paid:
    (1) As a deduction by the estate; or
    (2) If the estate was not liable to pay such obligation, as a 
deduction by the person who by bequest, devise, or inheritance from the 
decedent or by reason of the death of the decedent acquires, subject to 
such obligation, an interest in property of the decedent (or the prior 
decedent).

Similar treatment is given to the foreign tax credit provided by section 
33. For the purposes of subparagraph (2) of this paragraph, the right to 
receive an amount of gross income in respect of a decedent is considered 
property of the decedent; on the other hand, it is not necessary for a 
person, otherwise within the provisions of subparagraph (2) of this 
paragraph, to receive the right to any income in respect of a decedent. 
Thus, an heir who receives a right to income in respect of a decedent 
(by reason of the death of the decedent) subject to any income tax 
imposed by a foreign country during the decedent's

[[Page 272]]

life, which tax must be satisfied out of such income, is entitled to the 
credit provided by section 33 when he pays the tax. If a decedent who 
reported income by use of the cash receipts and disbursements method 
owned real property on which accrued taxes had become a lien, and if 
such property passed directly to the heir of the decedent in a 
jurisdiction in which real property does not become a part of a 
decedent's estate, the heir, upon paying such taxes, may take the same 
deduction under section 164 that would be allowed to the decedent if, 
while alive, he had made such payment.
    (b) The deduction for percentage depletion is allowable only to the 
person (described in section 691(a)(1)) who receives the income in 
respect of the decedent to which the deduction relates, whether or not 
such person receives the property from which such income is derived. 
Thus, an heir who (by reason of the decedent's death) receives income 
derived from sales of units of mineral by the decedent (who reported 
income by use of the cash receipts and disbursements method) shall be 
allowed the deduction for percentage depletion, computed on the gross 
income from such number of units as if the heir had the same economic 
interest in the property as the decedent. Such heir need not also 
receive any interest in the mineral property other than such income. If 
the decedent did not compute his deduction for depletion on the basis of 
percentage depletion, any deduction for depletion to which the decedent 
was entitled at the date of his death would be allowable in computing 
his taxable income for his last taxable year, and there can be no 
deduction in respect of the decedent by any other person for such 
depletion.



Sec. 1.691(c)-1   Deduction for estate tax attributable to income in respect of a decedent.

    (a) In general. A person who is required to include in gross income 
for any taxable year an amount of income in respect of a decedent may 
deduct for the same taxable year that portion of the estate tax imposed 
upon the decedent's estate which is attributable to the inclusion in the 
decedent's estate of the right to receive such amount. The deduction is 
determined as follows:
    (1) Ascertain the net value in the decedent's estate of the items 
which are included under section 691 in computing gross income. This is 
the excess of the value included in the gross estate on account of the 
items of gross income in respect of the decedent (see Sec. 1.691(a)-1 
and paragraph (c) of this section) over the deductions from the gross 
estate for claims which represent the deductions and credit in respect 
of the decedent (see Sec. 1.691(b)-1). But see section 691(d) and 
paragraph (b) of Sec. 1.691(d)-1 for computation of the special value of 
a survivor's annuity to be used in computing the net value for estate 
tax purposes in cases involving joint and survivor annuities.
    (2) Ascertain the portion of the estate tax attributable to the 
inclusion in the gross estate of such net value. This is the excess of 
the estate tax over the estate tax computed without including such net 
value in the gross estate. In computing the estate tax without including 
such net value in the gross estate, any estate tax deduction (such as 
the marital deduction) which may be based upon the gross estate shall be 
recomputed so as to take into account the exclusion of such net value 
from the gross estate. See example 2, paragraph (e) of Sec. 1.691(d)-1.

For purposes of this section, the term estate tax means the tax imposed 
under section 2001 or 2101 (or the corresponding provisions of the 
Internal Revenue Code of 1939), reduced by the credits against such tax. 
Each person including in gross income an amount of income in respect of 
a decedent may deduct as his share of the portion of the estate tax 
(computed under subparagraph (2) of this paragraph) an amount which 
bears the same ratio to such portion as the value in the gross estate of 
the right to the income included by such person in gross income (or the 
amount included in gross income if lower) bears to the value in the 
gross estate of all the items of gross income in respect of the 
decedent.
    (b) Prior decedent. If a person is required to include in gross 
income an amount of income in respect of a prior decedent, such person 
may deduct for the same taxable year that portion of

[[Page 273]]

the estate tax imposed upon the prior decedent's estate which is 
attributable to the inclusion in the prior decedent's estate of the 
value of the right to receive such amount. This deduction is computed in 
the same manner as provided in paragraph (a) of this section and is in 
addition to the deduction for estate tax imposed upon the decedent's 
estate which is attributable to the inclusion in the decedent's estate 
of the right to receive such amount.
    (c) Amounts deemed to be income in respect of a decedent. For 
purposes of allowing the deduction under section 691(c), the following 
items are also considered to be income in respect of a decedent under 
section 691(a):
    (1) The value for estate tax purposes of stock options in respect of 
which amounts are includible in gross income under section 421(b) (prior 
to amendment by section 221(a) of the Revenue Act of 1964), in the case 
of taxable years ending before January 1, 1964, or under section 
422(c)(1), 423(c), or 424(c)(1), whichever is applicable, in the case of 
taxable years ending after December 31, 1963. See section 421(d)(6) 
(prior to amendment by sec. 221(a) of the Revenue Act of 1964), in the 
case of taxable years ending before January 1, 1964, and section 
421(c)(2), in the case of taxable years ending after December 31, 1963.
    (2) Amounts received by a surviving annuitant during his life 
expectancy period as an annuity under a joint and survivor annuity 
contract to the extent included in gross income under section 72. See 
section 691(d).
    (d) Examples. Paragraphs (a) and (b) of this section may be 
illustrated by the following examples:

    Example 1. X, an attorney who kept his books by use of the cash 
receipts and disbursements method, was entitled at the date of his death 
to a fee for services rendered in a case not completed at the time of 
his death, which fee was valued in his estate at $1,000, and to accrued 
bond interest, which was valued in his estate at $500. In all, $1,500 
was included in his gross estate in respect of income described in 
section 691(a)(1). There were deducted as claims against his estate $150 
for business expenses for which his estate was liable and $50 for taxes 
accrued on certain property which he owned. In all, $200 was deducted 
for claims which represent amounts described in section 691(b) which are 
allowable as deductions to his estate or to the beneficiaries of his 
estate. His gross estate was $185,000 and, considering deductions of 
$15,000 and an exemption of $60,000, his taxable estate amounted to 
$110,000. The estate tax on this amount is $23,700 from which is 
subtracted a $75 credit for State death taxes leaving an estate tax 
liability of $23,625. In the year following the closing of X's estate, 
the fee in the amount of $1,200 was collected by X's son, who was the 
sole beneficiary of the estate. This amount was included under section 
691(a)(1)(C) in the son's gross income. The son may deduct, in computing 
his taxable income for such year, $260 on account of the estate tax 
attributable to such income, computed as follows:

(1) (i) Value of income described in section 691(a)(1)                  
 included in computing gross estate.........................      $1,500
(ii) Deductions in computing gross estate for claims                    
 representing deductions described in section 691(b)........         200
                                                             -----------
(iii) Net value of items described in section 691(a)(1).....       1,300
                                                             ===========
(2) (i) Estate tax..........................................      23,625
(ii) Less: Estate tax computed without including $1,300                 
 (item (1)(iii)) in gross estate............................      23,235
                                                             -----------
(iii) Portion of estate tax attributable to net value of                
 items described in section 691(a)(1).......................         390
                                                             ===========
(3) (i) Value in gross estate of items described in section             
 691(a)(1) received in taxable year (fee)...................       1,000
(ii) Value in gross estate of all income items described in             
 section 691(a)(1) (item (1)(i))............................       1,500
(iii) Part of estate tax deductible on account of receipt of            
 $1,200 fee (1,000/1,500 of $390)...........................         260
                                                                        

Although $1,200 was later collected as the fee, only the $1,000 actually 
included in the gross estate is used in the above computations. However, 
to avoid distortion, section 691(c) provides that if the value included 
in the gross estate is greater than the amount finally collected, only 
the amount collected shall be used in the above computations. Thus, if 
the amount collected as the fee were only $500, the estate tax 
deductible on the receipt of such amount would be 500/1,500 of $390, or 
$130. With respect to taxable years ending before January 1, 1964, see 
paragraph (d)(3) of Sec. 1.421-5 for a similar example involving a 
restricted stock option. With respect to taxable years ending after 
December 31, 1963, see paragraph (c)(3) of Sec. 1.421-8 for a similar 
example involving a stock option subject to the provisions of part II of 
subchapter D.

    Example 2. Assume that in example 1 the fee valued at $1,000 had 
been earned by prior decedent Y and had been inherited by X who died 
before collecting it. With regard to the son, the fee would be 
considered income in respect of a prior decedent. Assume further that 
the fee was valued at $1,000 in Y's estate, that the net value in Y's 
estate of items described in section 691 (a)(1) was

[[Page 274]]

$5,000 and that the estate tax imposed on Y's estate attributable to 
such net value was $550. In such case, the portion of such estate tax 
attributable to the fee would be 1,000/5,000 of $550, or $110. When the 
son collects the $1,200 fee, he will receive for the same taxable year a 
deduction of $110 with respect to the estate tax imposed on the estate 
of prior decedent Y as well as the deduction of $260 (as computed in 
example 1) with respect to the estate tax imposed on the estate of 
decedent X.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6887, 31 FR 
8812, June 24, 1966]



Sec. 1.691(c)-2   Estates and trusts.

    (a) In the case of an estate or trust, the deduction prescribed in 
section 691(c) is determined in the same manner as described in 
Sec. 1.691(c)-1, with the following exceptions:
    (1) If any amount properly paid, credited, or required to be 
distributed by an estate or trust to a beneficiary consists of income in 
respect of a decedent received by the estate or trust during the taxable 
year:
    (i) Such income shall be excluded in determining the income in 
respect of the decedent with respect to which the estate or trust is 
entitled to a deduction under section 691(c), and
    (ii) Such income shall be considered income in respect of a decedent 
to such beneficiary for purposes of allowing the deduction under section 
691(c) to such beneficiary.
    (2) For determination of the amount of income in respect of a 
decedent received by the beneficiary, see sections 652 and 662, and 
Secs. 1.652(b)-2 and 1.662(b)-2. However, for this purpose, 
distributable net income as defined in section 643 (a) and the 
regulations thereunder shall be computed without taking into account the 
estate tax deduction provided in section 691(c) and this section. 
Distributable net income as modified under the preceding sentence shall 
be applied for other relevant purposes of subchapter J, chapter 1 of the 
Code, such as the deduction provided by section 651 or 661, or subpart 
D, part I of subchapter J, relating to excess distributions by trusts.
    (3) The rule stated in subparagraph (1) of this paragraph does not 
apply to income in respect of a decedent which is properly allocable to 
corpus by the fiduciary during the taxable year but which is distributed 
to a beneficiary in a subsequent year. The deduction provided by section 
691(c) in such a case is allowable only to the estate or trust. If any 
amount properly paid, credited, or required to be distributed by a trust 
qualifies as a distribution under section 666, the fact that a portion 
thereof constitutes income in respect of a decedent shall be disregarded 
for the purposes of determining the deduction of the trust and of the 
beneficiaries under section 691(c) since the deduction for estate taxes 
was taken into consideration in computing the undistributed net income 
of the trust for the preceding taxable year.
    (b) This section shall apply only to amounts properly paid, 
credited, or required to be distributed in taxable years of an estate or 
trust beginning after December 31, 1953, and ending after August 16, 
1954, except as otherwise provided in paragraph (c) of this section.
    (c) In the case of an estate or trust heretofore taxable under the 
provisions of the Internal Revenue Code of 1939, amounts paid, credited, 
or to be distributed during its first taxable year subject to the 
Internal Revenue Code of 1954 which would have been treated as paid, 
credited, or to be distributed on the last day of the preceding taxable 
year if the Internal Revenue Code of 1939 were still applicable shall 
not be subject to the provisions of section 691(c)(1)(B) or this 
section. See section 683 and the regulations thereunder.
    (d) The provisions of this section may be illustrated by the 
following example, in which it is assumed that the estate and the 
beneficiary make their returns on the calendar year basis:

    Example. (1) The fiduciary of an estate receives taxable interest of 
$5,500 and income in respect of a decedent of $4,500 during the taxable 
year. Neither the will of the decedent nor local law requires the 
allocation to corpus of income in respect of a decedent. The estate tax 
attributable to the income in respect of a decedent is $1,500. In his 
discretion, the fiduciary distributes $2,000 (falling within sections 
661(a) and 662(a)) to a beneficiary during that year. On these facts the 
fiduciary and beneficiary are respectively entitled to estate tax 
deductions of $1,200 and $300, computed as follows:

[[Page 275]]

    (2) Distributable net income computed under section 643(a) without 
regard to the estate tax deduction under section 691(c) is $10,000, 
computed as follows:


Taxable interest.............................................     $5,500
Income in respect of a decedent..............................      4,500
                                                   ------------         
    Total....................................................     10,000
                                                                        

    (3) Inasmuch as the distributable net income of $10,000 exceeds the 
amount of $2,000 distributed to the beneficiary, the deduction allowable 
to the estate under section 661(a) and the amount taxable to the 
beneficiary under section 662(a) is $2,000.
    (4) The character of the amounts distributed to the beneficiary 
under section 662 (b) is shown in the following table:

------------------------------------------------------------------------
                                                    Income in           
                                          Taxable    respect            
                                          interest     of a      Total  
                                                     decedent           
------------------------------------------------------------------------
Distributable net income...............     $5,500     $4,500    $10,000
Amount deemed distributed under section                                 
 662(b)................................      1,100        900      2,000
------------------------------------------------------------------------

    (5) Accordingly, the beneficiary will be entitled to an estate tax 
deduction of $300 (900/4,500 x $1,500) and the estate will be entitled 
to an estate tax deduction of $1,200 (3,600/4,500 x $1,500).
    (6) The taxable income of the estate is $6,200, computed as follows:

Gross income.................................................    $10,000
Less:                                                                   
  Distributions to the beneficiary................     $2,000           
Estate tax deduction under section 691(c).........      1,200           
Personal exemption................................        600           
                                                                   3,800
                                                   ------------         
    Taxable income...........................................      6,200
                                                                        



Sec. 1.691(d)-1   Amounts received by surviving annuitant under joint and survivor annuity contract.

    (a) In general. Under section 691(d), annuity payments received by a 
surviving annuitant under a joint and survivor annuity contract (to the 
extent indicated in paragraph (b) of this section) are treated as income 
in respect of a decedent under section 691(a) for the purpose of 
allowing the deduction for estate tax provided for in section 
691(c)(1)(A). This section applies only if the deceased annuitant died 
after December 31, 1953, and after the annuity starting date as defined 
in section 72(c)(4).
    (b) Special value for surviving annuitant's payments. Section 691(d) 
provides a special value for the surviving annuitant's payments to 
determine the amount of the estate tax deduction provided for in section 
691(c)(1)(A). This special value is determined by multiplying:
    (1) The excess of the value of the annuity at the date of death of 
the deceased annuitant over the total amount excludable from the gross 
income of the surviving annuitant under section 72 during his life 
expectancy period (see paragraph (d)(1)(i) of this section)

by
    (2) A fraction consisting of the value of the annuity for estate tax 
purposes over the value of the annuity at the date of death of the 
deceased annuitant.

This special value is used for the purpose of determining the net value 
for estate tax purposes (see section 691(c)(2)(B) and paragraph (a)(1) 
of Sec. 1.691(c)-1) and for the purpose of determining the portion of 
estate tax attributable to the survivor's annuity (see paragraph (a) of 
Sec. 1.691(c)-1).
    (c) Amount of deduction. The portion of estate tax attributable to 
the survivor's annuity (see paragraph (a) of Sec. 1.691(c)-1) is 
allowable as a deduction to the surviving annuitant over his life 
expectancy period. If the surviving annuitant continues to receive 
annuity payments beyond this period, there is no further deduction under 
section 691(d). If the surviving annuitant dies before expiration of 
such period, there is no compensating adjustment for the unused 
deduction.
    (d) Definitions. (1) For purposes of section 691(d) and this 
section:
    (i) The term life expectancy period means the period beginning with 
the first day of the first period for which an amount is received by the 
surviving annuitant under the contract and ending with the close of the 
taxable year with or in which falls the termination of the life 
expectancy of the surviving annuitant.
    (ii) The life expectancy of the surviving annuitant shall be 
determined as of the date of death of the deceased annuitant, with 
reference to actuarial Table I set forth in Sec. 1.72-9 (but without 
making any adjustment under paragraph (a)(2) of Sec. 1.72-5).

[[Page 276]]

    (iii) The value of the annuity at the date of death of the deceased 
annuitant shall be the entire value of the survivor's annuity determined 
by reference to the principles set forth in section 2031 and the 
regulations thereunder, relating to the valuation of annuities for 
estate tax purposes.
    (iv) The value of the annuity for estate tax purposes shall be that 
portion of the value determined under subdivision (iii) of this 
subparagraph which was includible in the deceased annuitant's gross 
estate.
    (2) The determination of the ``life expectancy period'' of the 
survivor for purposes of section 691(d) may be illustrated by the 
following example:

    Example. H and W file their income tax returns on the calendar year 
basis. H dies on July 15, 1955, on which date W is 70 years of age. On 
August 1, 1955, W receives a monthly payment under a joint and survivor 
annuity contract. W's life expectancy determined as of the date of H's 
death is 15 years as determined from Table I in Sec. 1.72-9; thus her 
life expectancy ends on July 14, 1970. Under the provisions of section 
691(d), her life expectancy period begins as of July 1, 1955, and ends 
as of December 31, 1970, thus giving her a life expectancy period of 15 
1/2 years.

    (e) Examples. The application of section 691(d) and this section may 
be illustrated by the following examples:

    Example 1. (1) H and W, husband and wife, purchased a joint and 
survivor annuity contract for $203,800 providing for monthly payments of 
$1,000 starting January 28, 1954, and continuing for their joint lives 
and for the remaining life of the survivor. H contributed $152,850 and W 
contributed $50,950 to the cost of the annuity. As of the annuity 
starting date, January 1, 1954, H's age at his nearest birthday was 70 
and W's age at her nearest birthday was 67. H dies on January 1, 1957, 
and beginning on January 28, 1957, W receives her monthly payments of 
$1,000. The value of the annuity at the date of H's death is $159,000 
(see paragraph (d)(1)(iii) of this section), and the value of the 
annuity for estate tax purposes (see paragraph (d)(1)(iv) of this 
section) is $119,250 (152,850/203,800 of $159,000). As of the date of 
H's death, W's age is 70 and her life expectancy period is 15 years (see 
paragraph (d) of this section for method of computation). Both H and W 
reported income by use of the cash receipts and disbursements method and 
filed income tax returns on the calendar year basis.
    (2) The following computations illustrate the application of section 
72 in determining the excludable portions of the annuity payments to W 
during her life expectancy period:

Amount of annuity payments per year (12 x $1,000)............    $12,000
Life expectancy of H and W as of the annuity starting date              
 (see section 72(c)(3)(A) and Table II of Sec.  1.72-9 (male,           
 age 70; female, age 67))....................................       19.7
Expected return as of the annuity starting date, January 1,             
 1954 ($12,000 x 19.7 as determined under section 72(c)(3)(A)           
 and paragraph (b) of Sec.  1.72-5)..........................   $236,400
Investment in the contract as of the annuity starting date,             
 Jan. 1, 1954 (see section 72(c)(1) and paragraph (a) of Sec.           
  1.72-6)....................................................   $203,800
Exclusion ratio (203,800/236,400 as determined under section            
 72(b) and Sec.  1.72-4) (percent)...........................       86.2
Exclusion per year under section 72 ($12,000 x 86.2 percent).    $10,344
Excludable during W's life expectancy period ($10,344 x 15)..   $155,160
                                                                        

    (3) For the purpose of computing the deduction for estate tax under 
section 691(c), the value for estate tax purposes of the amounts 
includible in W's gross income and considered income in respect of a 
decedent by virtue of section 691(d)(1) is $2,880. This amount is 
arrived at in accordance with the formula contained in section 
691(d)(2), as follows:

Value of annuity at the date of H's death....................   $159,000
Total amount excludable from W's gross income under section             
 72 during W's life expectancy period (see subparagraph (2)             
 of this example)............................................   $155,160
Excess.......................................................     $3,840
Ratio which value of annuity for estate tax purposes bears to           
 value of annuity at date of H's death (119,250/159,000)                
 (percent)...................................................         75
Value for estate tax purposes (75 percent of $3,840).........     $2,880
                                                                        

This amount ($2,880) is included in the items of income under section 
691(a)(1) for the purpose of determining the estate tax attributable to 
each item under section 691(c)(1)(A). The estate tax determined to be 
attributable to the item of $2,880 is then allowed as a deduction to W 
over her 15-year life expectancy period (see example 2 of this 
paragraph).
    Example 2. Assume, in addition to the facts contained in example 1 
of this paragraph, that H was an attorney and was entitled at the date 
of his death to a fee for services rendered in a case not completed at 
the time of his death, which fee was valued at $1,000, and to accrued 
bond interest, which was valued at $500. Taking into consideration the 
annuity payments of example 1, valued at $2,880, a total of $4,380 was 
included in his gross estate in respect of income described in section 
691(a)(1). There were deducted as claims against his estate $280 for 
business expenses for which his estate was liable and $100 for taxes 
accrued on certain property which he owned. In all, $380 was deducted 
for claims which represent amounts described in section 691(b) which are 
allowable as deductions

[[Page 277]]

to his estate or to the beneficiaries of his estate. His gross estate 
was $404,250 and considering deductions of $15,000, a marital deduction 
of $119,250 (assuming the annuity to be the only qualifying gift) and an 
exemption of $60,000, his taxable estate amounted to $210,000. The 
estate tax on this amount is $53,700 from which is subtracted a $175 
credit for State death taxes, leaving an estate tax liability of 
$53,525. W may deduct, in computing her taxable income during each year 
of her 15-year life expectancy period, $14.73 on account of the estate 
tax attributable to the value for estate tax purposes of that portion of 
the annuity payments considered income in respect of a decedent, 
computed as follows:

(1)(i) Value of income described in section 691(a)(1)                   
 included in computing gross estate..........................  $4,380.00
(ii) Deductions in computing gross estate for claims                    
 representing deductions described in section 691(b).........     380.00
                                                   ------------         
    (iii) Net value of items described in section 691(a) (1).   4,000.00
                                                   ============         
(2)(i) Estate tax............................................  53,525.00
(ii) Less: estate tax computed without including $4,000 (item           
 (1) (iii)) in gross estate and by reducing marital deduction           
 by $2,880 (portion of item (1)(iii) allowed as a marital               
 deduction)..................................................  53,189.00
                                                   ------------         
    (iii) Portion of estate tax attributable to net value of            
     income items............................................     336.00
(3)(i) Value in gross estate of income attributable to                  
 annuity payments............................................   2,880.00
(ii) Value in gross estate of all income items described in             
 section 691(a)(1) (item (1)(i)).............................   4,380.00
(iii) Part of estate tax attributable to annuity income                 
 (2,880/4,380 of $336).......................................     220.93
(iv) Deduction each year on account of estate tax                       
 attributable to annuity income ($220.9315 (life                
 expectancy period)).........................................      14.73
                                                                        



Sec. 1.691(e)-1   Installment obligations transmitted at death when prior law applied.

    (a) In general--(1) Application of prior law. Under section 44(d) of 
the Internal Revenue Code of 1939 and corresponding provisions of prior 
law, gains and losses on account of the transmission of installment 
obligations at the death of a holder of such obligations were required 
to be reported in the return of the decedent for the year of his death. 
However, an exception to this rule was provided if there was filed with 
the Commissioner a bond assuring the return as income of any payment in 
satisfaction of these obligations in the same proportion as would have 
been returnable as income by the decedent had he lived and received such 
payments. Obligations in respect of which such bond was filed are 
referred to in this section as ``obligations assured by bond''.
    (2) Application of present law. Section 691(a)(4) of the Internal 
Revenue Code of 1954 (effective for taxable years beginning after 
December 31, 1953, and ending after August 16, 1954) in effect makes the 
exception which under prior law applied to obligations assured by bond 
the general rule for obligations transmitted at death, but contains no 
requirement for a bond. Section 691(e)(1) provides that if the holder of 
the installment obligation makes a proper election, the provisions of 
section 691(a)(4) shall apply in the case of obligations assured by 
bond. Section 691(e)(1) further provides that the estate tax deduction 
provided by section 691(c)(1) is not allowable for any amount included 
in gross income by reason of filing such an election.
    (b) Manner and scope of election--(1) In general. The election to 
have obligations assured by bond treated as obligations to which section 
691(a)(4) applies shall be made by the filing of a statement with 
respect to each bond to be released, containing the following 
information:
    (i) The name and address of the decedent from whom the obligations 
assured by bond were transmitted, the date of his death, and the 
internal revenue district in which the last income tax return of the 
decedent was filed.
    (ii) A schedule of all obligations assured by the bond on which is 
listed--
    (a) The name and address of the obligors, face amount, date of 
maturity, and manner of payment of each obligation,
    (b) The name, identifying number (provided under section 6109 and 
the regulations thereunder), and address of each person holding the 
obligations, and
    (c) The name, identifying number, and address, of each person who at 
the time of the election possesses an interest in each obligation, and a 
description of such interest.
    (iii) The total amount of income in respect of the obligations which 
would have been reportable as income by the decedent if he had lived and 
received such payment.

[[Page 278]]

    (iv) The amount of income referred to in subdivision (iii) of this 
subparagraph which has previously been included in gross income.
    (v) An unqualified statement, signed by all persons holding the 
obligations, that they elect to have the provisions of section 691(a)(4) 
apply to such obligations and that such election shall be binding upon 
them, all current beneficiaries, and any person to whom the obligations 
may be transmitted by gift, bequest, or inheritance.
    (vi) A declaration that the election is made under the penalties of 
perjury.
    (2) Filing of statement. The statement with respect to each bond to 
be released shall be filed in duplicate with the district director of 
internal revenue for the district in which the bond is maintained. The 
statement shall be filed not later than the time prescribed for filing 
the return for the first taxable year (including any extension of time 
for such filing) to which the election applies.
    (3) Effect of election. The election referred to in subparagraph (1) 
of this paragraph shall be irrevocable. Once an election is made with 
respect to an obligation assured by bond, it shall apply to all payments 
made in satisfaction of such obligation which were received during the 
first taxable year to which the election applies and to all such 
payments received during each taxable year thereafter, whether the 
recipient is the person who made the election, a current beneficiary, or 
a person to whom the obligation may be transmitted by gift, bequest, or 
inheritance. Therefore, all payments received to which the election 
applies shall be treated as payments made on installment obligations to 
which section 691(a)(4) applies. However, the estate tax deduction 
provided by section 691(c) is not allowable for any such payment. The 
application of this subparagraph may be illustrated by the following 
example:

    Example. A, the holder of an installment obligation, died in 1952. 
The installment obligation was transmitted at A's death to B who filed a 
bond on Form 1132 pursuant to paragraph (c) of Sec. 39.44-5 of 
Regulations 118 (26 CFR part 39, 1939 ed.) for the necessary amount. On 
January 1, 1965, B, a calendar year taxpayer, filed an election under 
section 691(e) to treat the obligation assured by bond as an obligation 
to which section 691(a)(4) applies, and B's bond was released for 1964 
and subsequent taxable years. B died on June 1, 1965, and the obligation 
was bequeathed to C. On January 1, 1966, C received an installment 
payment on the obligation which had been assured by the bond. Because B 
filed an election with respect to the obligation assured by bond, C is 
required to treat the proper proportion of the January 1, 1966, payment 
and all subsequent payments made in satisfaction of this obligation as 
income in respect of a decedent. However, no estate tax deduction is 
allowable to C under section 691(c)(1) for any estate tax attributable 
to the inclusion of the value of such obligation in the estate of either 
A or B.

    (c) Release of bond. If an election according to the provisions of 
paragraph (b) of this section is filed, the liability under any bond 
filed under section 44(d) of the 1939 Code (or the corresponding 
provisions of prior law) shall be released with respect to each taxable 
year to which such election applies. However, the liability under any 
such bond for an earlier taxable year to which the election does not 
apply shall not be released until the district director of internal 
revenue for the district in which the bond is maintained is assured that 
the proper portion of each installment payment received in such taxable 
year has been reported and the tax thereon paid.

[T.D. 6808, 30 FR 3436, Mar. 16, 1965]



Sec. 1.691(f)-1  Cross reference.

    See section 753 and the regulations thereunder for application of 
section 691 to income in respect of a deceased partner.

[T.D. 6808, 30 FR 3436, Mar. 16, 1965]



Sec. 1.692-1  Abatement of income taxes of certain members of the Armed Forces of the United States upon death.

    (a)(1) This section applies if:
    (i) An individual dies while in active service as a member of the 
Armed Forces of the United States, and
    (ii) His death occurs while he is serving in a combat zone (as 
determined under section 112), or at any place as a result of wounds, 
disease, or injury incurred while he was serving in a combat zone.

[[Page 279]]

    (2) If an individuals dies as described in paragraph (a)(1), the 
following liabilities for tax, under subtitle A of the Internal Revenue 
Code of 1954 or under chapter 1 of the Internal Revenue Code of 1939, 
are canceled:
    (i) The libaility of the deceased individual, for the last taxable 
year, ending on the date of his death, and for any prior taxable year 
ending on or after the first day he served in a combat zone in active 
service as a member of the U.S. Armed Forces after June 24, 1950, and
    (ii) The liability of any other person to the extent the liability 
is attributable to an amount received after the individual's death 
(including income in respect of a decedent under section 691) which 
would have been includible in the individual's gross income for his 
taxable year in which the date of his death falls (determined as if he 
had survived).

If the tax (including interest, additions to the tax, and additional 
amounts) is assessed, the assessment will be abated. If the amount of 
the tax is collected (regardless of the date of collection), the amount 
so collected will be credited or refunded as an overpayment.
    (3) If an individual dies as described in paragraph (a)(1), there 
will not be assessed any amount of tax of the indvidual for taxable 
years preceding the years specified in paragraph (a)(2), under subtitle 
A of the Internal Revenue Code of 1954, chapter 1 of the Internal 
Revenue Code of 1939, or corresponding provisions of prior revenue laws, 
remaining unpaid as of the date of death. If any such unpaid tax 
(including interest, additions to the tax, and additional amounts) has 
been assessed, the assessments will be abated. If the amount of any such 
unpaid tax is collected after the date of death, the amount so collected 
will be credited or refunded as an overpayment.
    (4) As to what constitutes active service as a member of the Armed 
Forces, service in a combat zone, and wounds, disease, or injury 
incurred while serving in a combat zone, see section 112. As to who are 
members of the Armed Forces, see section 7701(a)(15). As to the period 
of time within which any claim for refund must be filed, see sections 
6511(a) and 7508(a)(1)(E).
    (b) If such an individual and his spouse have for any such year 
filed a joint return, the tax abated, credited, or refunded pursuant to 
the provisions of section 692 for such year shall be an amount equal to 
that portion of the joint tax liability which is the same percentage of 
such joint tax liability as a tax computed upon the separate income of 
such individual is of the sum of the taxes computed upon the separate 
income of such individual and his spouse, but with respect to taxable 
years ending before June 24, 1950, and with respect to taxable years 
ending before the first day such individual served in a combat zone, as 
determined under section 112, the amount so abated, credited, or 
refunded shall not exceed the amount unpaid at the date of death. For 
such purpose, the separate tax of each spouse:
    (1) For taxable years beginning after December 31, 1953, and ending 
after August 16, 1954, shall be the tax computed under subtitle A of the 
Internal Revenue Code of 1954 before the application of sections 31, 32, 
6401(b), and 6402, but after the application of section 33, as if such 
spouse were required to make a separate income tax return; and
    (2) For taxable years beginning before January 1, 1954, and for 
taxable years beginning after December 31, 1953, and ending before 
August 17, 1954, shall be the tax computed under chapter 1 of the 
Internal Revenue Code of 1939 before the application of sections 32, 35, 
and 322(a), but after the application of section 31, as if such spouse 
were required to make a separate income tax return.
    (c) If such an individual and his spouse filed a joint declaration 
of estimated tax for the taxable year ending with the date of his death, 
the estimated tax paid pursuant to such declaration may be treated as 
the estimated tax of either such individual or his spouse, or may be 
divided between them, in such manner as his legal representative and 
such spouse may agree. Should they agree to treat such estimated tax, or 
any portion thereof, as the estimated tax of such individual, the 
estimated tax so paid shall be credited or refunded as an overpayment 
for

[[Page 280]]

the taxable year ending with the date of his death.
    (d) For the purpose of determining the tax which is unpaid at the 
date of death, amounts deducted and withheld under chapter 24, subtitle 
C of the Internal Revenue Code of 1954, or under subchapter D, chapter 9 
of the Internal Revenue Code of 1939 (relating to income tax withheld at 
source on wages), constitute payment of tax imposed under subtitle A of 
the Internal Revenue Code of 1954 or under chapter 1 of the Internal 
Revenue Code of 1939, as the case may be.
    (e) This section shall have no application whatsoever with respect 
to the liability of an individual as a transferee of property of a 
taxpayer where such liability relates to the tax imposed upon the 
taxpayer by subtitle A of the Internal Revenue Code of 1954 or by 
chapter 1 of the Internal Revenue Code of 1939.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7543, 43 FR 
19392, May 5, 1978]

                        Partners and Partnerships

                     determination of tax liability



Sec. 1.701-1   Partners, not partnership, subject to tax.

    Partners are liable for income tax only in their separate 
capacities. Partnerships as such are not subject to the income tax 
imposed by subtitle A but are required to make returns of income under 
the provisions of section 6031 and the regulations thereunder. For 
definition of the terms ``partner'' and ``partnership'', see sections 
761 and 7701(a)(2), and the regulations thereunder. For provisions 
relating to the election of certain partnerships to be taxed as domestic 
corporations, see section 1361 and the regulations thereunder.



Sec. 1.701-2  Anti-abuse rule.

    (a) Intent of subchapter K. Subchapter K is intended to permit 
taxpayers to conduct joint business (including investment) activities 
through a flexible economic arrangement without incurring an entity-
level tax. Implicit in the intent of subchapter K are the following 
requirements--
    (1) The partnership must be bona fide and each partnership 
transaction or series of related transactions (individually or 
collectively, the transaction) must be entered into for a substantial 
business purpose.
    (2) The form of each partnership transaction must be respected under 
substance over form principles.
    (3) Except as otherwise provided in this paragraph (a)(3), the tax 
consequences under subchapter K to each partner of partnership 
operations and of transactions between the partner and the partnership 
must accurately reflect the partners' economic agreement and clearly 
reflect the partner's income (collectively, proper reflection of 
income). However, certain provisions of subchapter K and the regulations 
thereunder were adopted to promote administrative convenience and other 
policy objectives, with the recognition that the application of those 
provisions to a transaction could, in some circumstances, produce tax 
results that do not properly reflect income. Thus, the proper reflection 
of income requirement of this paragraph (a)(3) is treated as satisfied 
with respect to a transaction that satisfies paragraphs (a)(1) and (2) 
of this section to the extent that the application of such a provision 
to the transaction and the ultimate tax results, taking into account all 
the relevant facts and circumstances, are clearly contemplated by that 
provision. See, for example, paragraph (d) Example 6 of this section 
(relating to the value-equals-basis rule in Sec. 1.704-1(b)(2)(iii)(c)), 
paragraph (d) Example 9 of this section (relating to the election under 
section 754 to adjust basis in partnership property), and paragraph (d) 
Examples 10 and 11 of this section (relating to the basis in property 
distributed by a partnership under section 732). See also, for example, 
Secs. 1.704-3(e)(1) and 1.752-2(e)(4) (providing certain de minimis 
exceptions).
    (b) Application of subchapter K rules. The provisions of subchapter 
K and the regulations thereunder must be applied in a manner that is 
consistent with the intent of subchapter K as set forth in paragraph (a) 
of this section (intent of subchapter K). Accordingly, if a partnership 
is formed or availed of in connection with a transaction a principal

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purpose of which is to reduce substantially the present value of the 
partners' aggregate federal tax liability in a manner that is 
inconsistent with the intent of subchapter K, the Commissioner can 
recast the transaction for federal tax purposes, as appropriate to 
achieve tax results that are consistent with the intent of subchapter K, 
in light of the applicable statutory and regulatory provisions and the 
pertinent facts and circumstances. Thus, even though the transaction may 
fall within the literal words of a particular statutory or regulatory 
provision, the Commissioner can determine, based on the particular facts 
and circumstances, that to achieve tax results that are consistent with 
the intent of subchapter K--
    (1) The purported partnership should be disregarded in whole or in 
part, and the partnership's assets and activities should be considered, 
in whole or in part, to be owned and conducted, respectively, by one or 
more of its purported partners;
    (2) One or more of the purported partners of the partnership should 
not be treated as a partner;
    (3) The methods of accounting used by the partnership or a partner 
should be adjusted to reflect clearly the partnership's or the partner's 
income;
    (4) The partnership's items of income, gain, loss, deduction, or 
credit should be reallocated; or
    (5) The claimed tax treatment should otherwise be adjusted or 
modified.
    (c) Facts and circumstances analysis; factors. Whether a partnership 
was formed or availed of with a principal purpose to reduce 
substantially the present value of the partners' aggregate federal tax 
liability in a manner inconsistent with the intent of subchapter K is 
determined based on all of the facts and circumstances, including a 
comparison of the purported business purpose for a transaction and the 
claimed tax benefits resulting from the transaction. The factors set 
forth below may be indicative, but do not necessarily establish, that a 
partnership was used in such a manner. These factors are illustrative 
only, and therefore may not be the only factors taken into account in 
making the determination under this section. Moreover, the weight given 
to any factor (whether specified in this paragraph or otherwise) depends 
on all the facts and circumstances. The presence or absence of any 
factor described in this paragraph does not create a presumption that a 
partnership was (or was not) used in such a manner. Factors include:
    (1) The present value of the partners' aggregate federal tax 
liability is substantially less than had the partners owned the 
partnership's assets and conducted the partnership's activities 
directly;
    (2) The present value of the partners' aggregate federal tax 
liability is substantially less than would be the case if purportedly 
separate transactions that are designed to achieve a particular end 
result are integrated and treated as steps in a single transaction. For 
example, this analysis may indicate that it was contemplated that a 
partner who was necessary to achieve the intended tax results and whose 
interest in the partnership was liquidated or disposed of (in whole or 
in part) would be a partner only temporarily in order to provide the 
claimed tax benefits to the remaining partners;
    (3) One or more partners who are necessary to achieve the claimed 
tax results either have a nominal interest in the partnership, are 
substantially protected from any risk of loss from the partnership's 
activities (through distribution preferences, indemnity or loss guaranty 
agreements, or other arrangements), or have little or no participation 
in the profits from the partnership's activities other than a preferred 
return that is in the nature of a payment for the use of capital;
    (4) Substantially all of the partners (measured by number or 
interests in the partnership) are related (directly or indirectly) to 
one another;
    (5) Partnership items are allocated in compliance with the literal 
language of Secs. 1.704-1 and 1.704-2 but with results that are 
inconsistent with the purpose of section 704(b) and those regulations. 
In this regard, particular scrutiny will be paid to partnerships in 
which income or gain is specially allocated to one or more partners that 
may be legally or effectively exempt from federal taxation (for example, 
a foreign

[[Page 282]]

person, an exempt organization, an insolvent taxpayer, or a taxpayer 
with unused federal tax attributes such as net operating losses, capital 
losses, or foreign tax credits);
    (6) The benefits and burdens of ownership of property nominally 
contributed to the partnership are in substantial part retained 
(directly or indirectly) by the contributing partner (or a related 
party); or
    (7) The benefits and burdens of ownership of partnership property 
are in substantial part shifted (directly or indirectly) to the 
distributee partner before or after the property is actually distributed 
to the distributee partner (or a related party).
    (d) Examples. The following examples illustrate the principles of 
paragraphs (a), (b), and (c) of this section. The examples set forth 
below do not delineate the boundaries of either permissible or 
impermissible types of transactions. Further, the addition of any facts 
or circumstances that are not specifically set forth in an example (or 
the deletion of any facts or circumstances) may alter the outcome of the 
transaction described in the example. Unless otherwise indicated, 
parties to the transactions are not related to one another.

    Example 1. Choice of entity; avoidance of entity-level tax; use of 
partnership consistent with the intent of subchapter K. (i) A and B form 
limited partnership PRS to conduct a bona fide business. A, the 
corporate general partner, has a 1% partnership interest. B, the 
individual limited partner, has a 99% interest. PRS is properly 
classified as a partnership under Secs. 301.7701-2 and 301.7701-3. A and 
B chose limited partnership form as a means to provide B with limited 
liability without subjecting the income from the business operations to 
an entity-level tax.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. 
Although B has retained, indirectly, substantially all of the benefits 
and burdens of ownership of the money or property B contributed to PRS 
(see paragraph (c)(6) of this section), the decision to organize and 
conduct business through PRS under these circumstances is consistent 
with this intent. In addition, on these facts, the requirements of 
paragraphs (a)(1), (2), and (3) of this section have been satisfied. The 
Commissioner therefore cannot invoke paragraph (b) of this section to 
recast the transaction.
    Example 2. Choice of entity; avoidance of subchapter S shareholder 
requirements; use of partnership consistent with the intent of 
subchapter K. (i) A and B form partnership PRS to conduct a bona fide 
business. A is a corporation that has elected to be treated as an S 
corporation under subchapter S. B is a nonresident alien. PRS is 
properly classified as a partnership under Secs. 301.7701-2 and 
301.7701-3. Because section 1361(b) prohibits B from being a shareholder 
in A, A and B chose partnership form, rather than admit B as a 
shareholder in A, as a means to retain the benefits of subchapter S 
treatment for A and its shareholders.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1), (2), and (3) of this section have been satisfied. Although it 
may be argued that the form of the partnership transaction should not be 
respected because it does not reflect its substance (inasmuch as 
application of the substance over form doctrine arguably could result in 
B being treated as a shareholder of A, thereby invalidating A's 
subchapter S election), the facts indicate otherwise. The shareholders 
of A are subject to tax on their pro rata shares of A's income (see 
section 1361 et seq.), and B is subject to tax on B's distributive share 
of partnership income (see sections 871 and 875). Thus, the form in 
which this arrangement is cast accurately reflects its substance as a 
separate partnership and S corporation. The Commissioner therefore 
cannot invoke paragraph (b) of this section to recast the transaction.
    Example 3. Choice of entity; avoidance of more restrictive foreign 
tax credit limitation; use of partnership consistent with the intent of 
subchapter K. (i) X, a domestic corporation, and Y, a foreign 
corporation, form partnership PRS under the laws of foreign Country A to 
conduct a bona fide joint business. X and Y each owns a 50% interest in 
PRS. PRS is properly classified as a partnership under Secs. 301.7701-2 
and 301.7701-3. PRS pays income taxes to Country A. X and Y chose 
partnership form to enable X to qualify for a direct foreign tax credit 
under section 901, with look-through treatment under Sec. 1.904-5(h)(1). 
Conversely, if PRS were a foreign corporation for U.S. tax purposes, X 
would be entitled only to indirect foreign tax credits under section 902 
with respect to dividend distributions from PRS. The look-through rules, 
however, would not apply, and pursuant to section 904(d)(1)(E) and 
Sec. 1.904-4(g), the dividends and associated taxes would be subject to 
a separate foreign tax credit limitation for dividends from PRS, a 
noncontrolled section 902 corporation.

[[Page 283]]

    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS in order to take 
advantage of the look-through rules for foreign tax credit purposes, 
thereby maximizing X's use of its proper share of foreign taxes paid by 
PRS, is consistent with this intent. In addition, on these facts, the 
requirements of paragraphs (a)(1), (2), and (3) of this section have 
been satisfied. The Commissioner therefore cannot invoke paragraph (b) 
of this section to recast the transaction.
    Example 4. Choice of entity; avoidance of gain recognition under 
sections 351(e) and 357(c); use of partnership consistent with the 
intent of subchapter K. (i) X, ABC, and DEF form limited partnership PRS 
to conduct a bona fide real estate management business. PRS is properly 
classified as a partnership under Secs. 301.7701-2 and 301.7701-3. X, 
the general partner, is a newly formed corporation that elects to be 
treated as a real estate investment trust as defined in section 856. X 
offers its stock to the public and contributes substantially all of the 
proceeds from the public offering to PRS. ABC and DEF, the limited 
partners, are existing partnerships with substantial real estate 
holdings. ABC and DEF contribute all of their real property assets to 
PRS, subject to liabilities that exceed their respective aggregate bases 
in the real property contributed, and terminate under section 
708(b)(1)(A). In addition, some of the former partners of ABC and DEF 
each have the right, beginning two years after the formation of PRS, to 
require the redemption of their limited partnership interests in PRS in 
exchange for cash or X stock (at X's option) equal to the fair market 
value of their respective interests in PRS at the time of the 
redemption. These partners are not compelled, as a legal or practical 
matter, to exercise their exchange rights at any time. X, ABC, and DEF 
chose to form a partnership rather than have ABC and DEF invest directly 
in X to allow ABC and DEF to avoid recognition of gain under sections 
351(e) and 357(c). Because PRS would not be treated as an investment 
company within the meaning of section 351(e) if PRS were incorporated 
(so long as it did not elect under section 856), section 721(a) applies 
to the contribution of the real property to PRS. See section 721(b).
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS, thereby avoiding 
the tax consequences that would have resulted from contributing the 
existing partnerships' real estate assets to X (by applying the rules of 
sections 721, 731, and 752 in lieu of the rules of sections 351(e) and 
357(c)), is consistent with this intent. In addition, on these facts, 
the requirements of paragraphs (a)(1), (2), and (3) of this section have 
been satisfied. Although it may be argued that the form of the 
transaction should not be respected because it does not reflect its 
substance (inasmuch as the present value of the partners' aggregate 
federal tax liability is substantially less than would be the case if 
the transaction were integrated and treated as a contribution of the 
encumbered assets by ABC and DEF directly to X, see paragraph (c)(2) of 
this section), the facts indicate otherwise. For example, the right of 
some of the former ABC and DEF partners after two years to exchange 
their PRS interests for cash or X stock (at X's option) equal to the 
fair market value of their PRS interest at that time would not require 
that right to be considered as exercised prior to its actual exercise. 
Moreover, X may make other real estate investments and other business 
decisions, including the decision to raise additional capital for those 
purposes. Thus, although it may be likely that some or all of the 
partners with the right to do so will, at some point, exercise their 
exchange rights, and thereby receive either cash or X stock, the form of 
the transaction as a separate partnership and real estate investment 
trust is respected under substance over form principles (see paragraph 
(a)(2) of this section). The Commissioner therefore cannot invoke 
paragraph (b) of this section to recast the transaction.
    Example 5. Special allocations; dividends received deductions; use 
of partnership consistent with the intent of subchapter K. (i) 
Corporations X and Y contribute equal amounts to PRS, a bona fide 
partnership formed to make joint investments. PRS pays $100x for a share 
of common stock of Z, an unrelated corporation, which has historically 
paid an annual dividend of $6x. PRS specially allocates the dividend 
income on the Z stock to X to the extent of the London Inter-Bank 
Offered Rate (LIBOR) on the record date, applied to X's contribution of 
$50x, and allocates the remainder of the dividend income to Y. All other 
items of partnership income and loss are allocated equally between X and 
Y. The allocations under the partnership agreement have substantial 
economic effect within the meaning of Sec. 1.704-1(b)(2). In addition to 
avoiding an entity-level tax, a principal purpose for the formation of 
the partnership was to invest in the Z common stock and to allocate the 
dividend income from the stock to provide X with a floating-rate return 
based on LIBOR, while permitting X and Y to claim the dividends received 
deduction under section 243 on the dividends allocated to each of them.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement

[[Page 284]]

without incurring an entity-level tax. See paragraph (a) of this 
section. The decision to organize and conduct business through PRS is 
consistent with this intent. In addition, on these facts, the 
requirements of paragraphs (a)(1), (2), and (3) of this section have 
been satisfied. Section 704(b) and Sec. 1.704-1(b)(2) permit income 
realized by the partnership to be allocated validly to the partners 
separate from the partners' respective ownership of the capital to which 
the allocations relate, provided that the allocations satisfy both the 
literal requirements of the statute and regulations and the purpose of 
those provisions (see paragraph (c)(5) of this section). Section 
704(e)(2) is not applicable to the facts of this example (otherwise, the 
allocations would be required to be proportionate to the partners' 
ownership of contributed capital). The Commissioner therefore cannot 
invoke paragraph (b) of this section to recast the transaction.
    Example 6. Special allocations; nonrecourse financing; low-income 
housing credit; use of partnership consistent with the intent of 
subchapter K. (i) A and B, high-bracket taxpayers, and X, a corporation 
with net operating loss carryforwards, form general partnership PRS to 
own and operate a building that qualifies for the low-income housing 
credit provided by section 42. The project is financed with both cash 
contributions from the partners and nonrecourse indebtedness. The 
partnership agreement provides for special allocations of income and 
deductions, including the allocation of all depreciation deductions 
attributable to the building to A and B equally in a manner that is 
reasonably consistent with allocations that have substantial economic 
effect of some other significant partnership item attributable to the 
building. The section 42 credits are allocated to A and B in accordance 
with the allocation of depreciation deductions. PRS's allocations comply 
with all applicable regulations, including the requirements of 
Secs. 1.704-1(b)(2)(ii) (pertaining to economic effect) and 1.704-2(e) 
(requirements for allocations of nonrecourse deductions). The 
nonrecourse indebtedness is validly allocated to the partners under the 
rules of Sec. 1.752-3, thereby increasing the basis of the partners' 
respective partnership interests. The basis increase created by the 
nonrecourse indebtedness enables A and B to deduct their distributive 
share of losses from the partnership (subject to all other applicable 
limitations under the Internal Revenue Code) against their 
nonpartnership income and to apply the credits against their tax 
liability.
    (ii) At a time when the depreciation deductions attributable to the 
building are not treated as nonrecourse deductions under Sec. 1.704-2(c) 
(because there is no net increase in partnership minimum gain during the 
year), the special allocation of depreciation deductions to A and B has 
substantial economic effect because of the value-equals-basis safe 
harbor contained in Sec. 1.704-1(b)(2)(iii)(c) and the fact that A and B 
would bear the economic burden of any decline in the value of the 
building (to the extent of the partnership's investment in the 
building), notwithstanding that A and B believe it is unlikely that the 
building will decline in value (and, accordingly, they anticipate 
significant timing benefits through the special allocation). Moreover, 
in later years, when the depreciation deductions attributable to the 
building are treated as nonrecourse deductions under Sec. 1.704-2(c), 
the special allocation of depreciation deductions to A and B is 
considered to be consistent with the partners' interests in the 
partnership under Sec. 1.704-2(e).
    (iii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a) (1), (2), and (3) of this section have been satisfied. Section 
704(b), Sec. 1.704-1(b)(2), and Sec. 1.704-2(e) allow partnership items 
of income, gain, loss, deduction, and credit to be allocated validly to 
the partners separate from the partners' respective ownership of the 
capital to which the allocations relate, provided that the allocations 
satisfy both the literal requirements of the statute and regulations and 
the purpose of those provisions (see paragraph (c)(5) of this section). 
Moreover, the application of the value-equals-basis safe harbor and the 
provisions of Sec. 1.704-2(e) with respect to the allocations to A and 
B, and the tax results of the application of those provisions, taking 
into account all the facts and circumstances, are clearly contemplated. 
Accordingly, even if the allocations would not otherwise be considered 
to satisfy the proper reflection of income standard in paragraph (a)(3) 
of this section, that requirement will be treated as satisfied under 
these facts. Thus, even though the partners' aggregate federal tax 
liability may be substantially less than had the partners owned the 
partnership's assets directly (due to X's inability to use its allocable 
share of the partnership's losses and credits) (see paragraph (c)(1) of 
this section), the transaction is not inconsistent with the intent of 
subchapter K. The Commissioner therefore cannot invoke paragraph (b) of 
this section to recast the transaction.
    Example 7. Partner with nominal interest; temporary partner; use of 
partnership not consistent with the intent of subchapter K. (i) Pursuant 
to a plan a principal purpose of which is to generate artificial losses 
and thereby shelter from federal taxation a substantial amount of 
income, X (a foreign corporation),

[[Page 285]]

Y (a domestic corporation), and Z (a promoter) form partnership PRS by 
contributing $9,000x, $990x, and $10x, respectively, for proportionate 
interests (90.0%, 9.9%, and 0.1%, respectively) in the capital and 
profits of PRS. PRS purchases offshore equipment for $10,000x and 
validly leases the equipment offshore for a term representing most of 
its projected useful life. Shortly thereafter, PRS sells its rights to 
receive income under the lease to a third party for $9,000x, and 
allocates the resulting $9,000x of income $8,100x to X, $891x to Y, and 
$9x to Z. PRS thereafter makes a distribution of $9,000x to X in 
complete liquidation of its interest. Under Sec. 1.704-1(b)(2)(iv)(f), 
PRS restates the partners' capital accounts immediately before making 
the liquidating distribution to X to reflect its assets consisting of 
the offshore equipment worth $1,000x and $9,000x in cash. Thus, because 
the capital accounts immediately before the distribution reflect assets 
of $19,000x (that is, the initial capital contributions of $10,000x plus 
the $9,000x of income realized from the sale of the lease), PRS 
allocates a $9,000x book loss among the partners (for capital account 
purposes only), resulting in restated capital accounts for X, Y, and Z 
of $9,000x, $990x, and $10x, respectively. Thereafter, PRS purchases 
real property by borrowing the $8,000x purchase price on a recourse 
basis, which increases Y's and Z's bases in their respective partnership 
interests from $1,881x and $19x, to $9,801x and $99x, respectively 
(reflecting Y's and Z's adjusted interests in the partnership of 99% and 
1%, respectively). PRS subsequently sells the offshore equipment, 
subject to the lease, for $1,000x and allocates the $9,000x tax loss 
$8,910x to Y and $90x to Z. Y's and Z's bases in their partnership 
interests are therefore reduced to $891x and $9x, respectively.
    (ii) On these facts, any purported business purpose for the 
transaction is insignificant in comparison to the tax benefits that 
would result if the transaction were respected for federal tax purposes 
(see paragraph (c) of this section). Accordingly, the transaction lacks 
a substantial business purpose (see paragraph (a)(1) of this section). 
In addition, factors (1), (2), (3), and (5) of paragraph (c) of this 
section indicate that PRS was used with a principal purpose to reduce 
substantially the partners' tax liability in a manner inconsistent with 
the intent of subchapter K. On these facts, PRS is not bona fide (see 
paragraph (a)(1) of this section), and the transaction is not respected 
under applicable substance over form principles (see paragraph (a)(2) of 
this section) and does not properly reflect the income of Y (see 
paragraph (a)(3) of this section). Thus, PRS has been formed and availed 
of with a principal purpose of reducing substantially the present value 
of the partners' aggregate federal tax liability in a manner 
inconsistent with the intent of subchapter K. Therefore (in addition to 
possibly challenging the transaction under judicial principles or the 
validity of the allocations under Sec. 1.704-1(b)(2) (see paragraph (h) 
of this section)), the Commissioner can recast the transaction as 
appropriate under paragraph (b) of this section.
    Example 8. Plan to duplicate losses through absence of section 754 
election; use of partnership not consistent with the intent of 
subchapter K. (i) A owns land with a basis of $100x and a fair market 
value of $60x. A would like to sell the land to B. A and B devise a plan 
a principal purpose of which is to permit the duplication, for a 
substantial period of time, of the tax benefit of A's built-in loss in 
the land. To effect this plan, A, C (A's brother), and W (C's wife) form 
partnership PRS, to which A contributes the land, and C and W each 
contribute $30x. All partnership items are shared in proportion to the 
partners' respective contributions to PRS. PRS invests the cash in an 
investment asset (that is not a marketable security within the meaning 
of section 731(c)). PRS also leases the land to B under a three-year 
lease pursuant to which B has the option to purchase the land from PRS 
upon the expiration of the lease for an amount equal to its fair market 
value at that time. All lease proceeds received are immediately 
distributed to the partners. In year 3, at a time when the values of the 
partnership's assets have not materially changed, PRS agrees with A to 
liquidate A's interest in exchange for the investment asset held by PRS. 
Under section 732(b), A's basis in the asset distributed equals $100x, 
A's basis in A's partnership interest immediately before the 
distribution. Shortly thereafter, A sells the investment asset to X, an 
unrelated party, recognizing a $40x loss.
    (ii) PRS does not make an election under section 754. Accordingly, 
PRS's basis in the land contributed by A remains $100x. At the end of 
year 3, pursuant to the lease option, PRS sells the land to B for $60x 
(its fair market value). Thus, PRS recognizes a $40x loss on the sale, 
which is allocated equally between C and W. C's and W's bases in their 
partnership interests are reduced to $10x each pursuant to section 705. 
Their respective interests are worth $30x each. Thus, upon liquidation 
of PRS (or their interests therein), each of C and W will recognize $20x 
of gain. However, PRS's continued existence defers recognition of that 
gain indefinitely. Thus, if this arrangement is respected, C and W 
duplicate for their benefit A's built-in loss in the land prior to its 
contribution to PRS.
    (iii) On these facts, any purported business purpose for the 
transaction is insignificant in comparison to the tax benefits that 
would result if the transaction were respected for federal tax purposes 
(see paragraph (c) of this section). Accordingly, the transaction lacks 
a substantial business purpose (see

[[Page 286]]

paragraph (a)(1) of this section). In addition, factors (1), (2), and 
(4) of paragraph (c) of this section indicate that PRS was used with a 
principal purpose to reduce substantially the partners' tax liability in 
a manner inconsistent with the intent of subchapter K. On these facts, 
PRS is not bona fide (see paragraph (a)(1) of this section), and the 
transaction is not respected under applicable substance over form 
principles (see paragraph (a)(2) of this section). Further, the tax 
consequences to the partners do not properly reflect the partners' 
income; and Congress did not contemplate application of section 754 to 
partnerships such as PRS, which was formed for a principal purpose of 
producing a double tax benefit from a single economic loss (see 
paragraph (a)(3) of this section). Thus, PRS has been formed and availed 
of with a principal purpose of reducing substantially the present value 
of the partners' aggregate federal tax liability in a manner 
inconsistent with the intent of subchapter K. Therefore (in addition to 
possibly challenging the transaction under judicial principles or other 
statutory authorities, such as the substance over form doctrine or the 
disguised sale rules under section 707 (see paragraph (h) of this 
section)), the Commissioner can recast the transaction as appropriate 
under paragraph (b) of this section.
    Example 9. Absence of section 754 election; use of partnership 
consistent with the intent of subchapter K. (i) PRS is a bona fide 
partnership formed to engage in investment activities with contributions 
of cash from each partner. Several years after joining PRS, A, a partner 
with a capital account balance and basis in its partnership interest of 
$100x, wishes to withdraw from PRS. The partnership agreement entitles A 
to receive the balance of A's capital account in cash or securities 
owned by PRS at the time of withdrawal, as mutually agreed to by A and 
the managing general partner, P. P and A agree to distribute to A $100x 
worth of non-marketable securities (see section 731(c)) in which PRS has 
an aggregate basis of $20x. Upon distribution, A's aggregate basis in 
the securities is $100x under section 732(b). PRS does not make an 
election to adjust the basis in its remaining assets under section 754. 
Thus, PRS's basis in its remaining assets is unaffected by the 
distribution. In contrast, if a section 754 election had been in effect 
for the year of the distribution, under these facts section 734(b) would 
have required PRS to adjust the basis in its remaining assets downward 
by the amount of the untaxed appreciation in the distributed property, 
thus reflecting that gain in PRS's retained assets. In selecting the 
assets to be distributed, A and P had a principal purpose to take 
advantage of the facts that A's basis in the securities will be 
determined by reference to A's basis in its partnership interest under 
section 732(b), and because PRS will not make an election under section 
754, the remaining partners of PRS will likely enjoy a federal tax 
timing advantage (i.e., from the $80x of additional basis in its assets 
that would have been eliminated if the section 754 election had been 
made) that is inconsistent with proper reflection of income under 
paragraph (a)(3) of this section.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1) and (2) of this section have been satisfied. The validity of the 
tax treatment of this transaction is therefore dependent upon whether 
the transaction satisfies (or is treated as satisfying) the proper 
reflection of income standard under paragraph (a)(3) of this section. 
A's basis in the distributed securities is properly determined under 
section 732(b). The benefit to the remaining partners is a result of PRS 
not having made an election under section 754. Subchapter K is generally 
intended to produce tax consequences that achieve proper reflection of 
income. However, paragraph (a)(3) of this section provides that if the 
application of a provision of subchapter K produces tax results that do 
not properly reflect income, but application of that provision to the 
transaction and the ultimate tax results, taking into account all the 
relevant facts and circumstances, are clearly contemplated by that 
provision (and the transaction satisfies the requirements of paragraphs 
(a)(1) and (2) of this section), then the application of that provision 
to the transaction will be treated as satisfying the proper reflection 
of income standard.
    (iii) In general, the adjustments that would be made if an election 
under section 754 were in effect are necessary to minimize distortions 
between the partners' bases in their partnership interests and the 
partnership's basis in its assets following, for example, a distribution 
to a partner. The electivity of section 754 is intended to provide 
administrative convenience for bona fide partnerships that are engaged 
in transactions for a substantial business purpose, by providing those 
partnerships the option of not adjusting their bases in their remaining 
assets following a distribution to a partner. Congress clearly 
recognized that if the section 754 election were not made, basis 
distortions may result. Taking into account all the facts and 
circumstances of the transaction, the electivity of section 754 in the 
context of the distribution from PRS to A, and the ultimate tax 
consequences that follow from the failure to make the election with 
respect to the transaction, are clearly contemplated by section 754. 
Thus, the tax consequences of this transaction will be treated as 
satisfying

[[Page 287]]

the proper reflection of income standard under paragraph (a)(3) of this 
section. The Commissioner therefore cannot invoke paragraph (b) of this 
section to recast the transaction.
    Example 10. Basis adjustments under section 732; use of partnership 
consistent with the intent of subchapter K. (i) A, B, and C are partners 
in partnership PRS, which has for several years been engaged in 
substantial bona fide business activities. For valid business reasons, 
the partners agree that A's interest in PRS, which has a value and basis 
of $100x, will be liquidated with the following assets of PRS: a 
nondepreciable asset with a value of $60x and a basis to PRS of $40x, 
and related equipment with two years of cost recovery remaining and a 
value and basis to PRS of $40x. Neither asset is described in section 
751 and the transaction is not described in section 732(d). Under 
section 732 (b) and (c), A's $100x basis in A's partnership interest 
will be allocated between the nondepreciable asset and the equipment 
received in the liquidating distribution in proportion to PRS's bases in 
those assets, or $50x to the nondepreciable asset and $50x to the 
equipment. Thus, A will have a $10x built-in gain in the nondepreciable 
asset ($60x value less $50x basis) and a $10x built-in loss in the 
equipment ($50x basis less $40x value), which it expects to recover 
rapidly through cost recovery deductions. In selecting the assets to be 
distributed to A, the partners had a principal purpose to take advantage 
of the fact that A's basis in the assets will be determined by reference 
to A's basis in A's partnership interest, thus, in effect, shifting a 
portion of A's basis from the nondepreciable asset to the equipment, 
which in turn would allow A to recover that portion of its basis more 
rapidly. This shift provides a federal tax timing advantage to A, with 
no offsetting detriment to B or C.
    (ii) Subchapter K is intended to permit taxpayers to conduct joint 
business activity through a flexible economic arrangement without 
incurring an entity-level tax. See paragraph (a) of this section. The 
decision to organize and conduct business through PRS is consistent with 
this intent. In addition, on these facts, the requirements of paragraphs 
(a)(1) and (2) of this section have been satisfied. The validity of the 
tax treatment of this transaction is therefore dependent upon whether 
the transaction satisfies (or is treated as satisfying) the proper 
reflection of income standard under paragraph (a)(3) of this section. 
Subchapter K is generally intended to produce tax consequences that 
achieve proper reflection of income. However, paragraph (a)(3) of this 
section provides that if the application of a provision of subchapter K 
produces tax results that do not properly reflect income, but the 
application of that provision to the transaction and the ultimate tax 
results, taking into account all the relevant facts and circumstances, 
are clearly contemplated by that provision (and the transaction 
satisfies the requirements of paragraphs (a)(1) and (2) of this 
section), then the application of that provision to the transaction will 
be treated as satisfying the proper reflection of income standard.
    (iii) A's basis in the assets distributed to it was determined under 
section 732 (b) and (c). The transaction does not properly reflect A's 
income due to the basis distortions caused by the distribution and the 
shifting of basis from a nondepreciable to a depreciable asset. However, 
the basis rules under section 732, which in some situations can produce 
tax results that are inconsistent with the proper reflection of income 
standard (see paragraph (a)(3) of this section), are intended to provide 
simplifying administrative rules for bona fide partnerships that are 
engaged in transactions with a substantial business purpose. Taking into 
account all the facts and circumstances of the transaction, the 
application of the basis rules under section 732 to the distribution 
from PRS to A, and the ultimate tax consequences of the application of 
that provision of subchapter K, are clearly contemplated. Thus, the 
application of section 732 to this transaction will be treated as 
satisfying the proper reflection of income standard under paragraph 
(a)(3) of this section. The Commissioner therefore cannot invoke 
paragraph (b) of this section to recast the transaction.
    Example 11. Basis adjustments under section 732; plan or arrangement 
to distort basis allocations artificially; use of partnership not 
consistent with the intent of subchapter K. (i) Partnership PRS has for 
several years been engaged in the development and management of 
commercial real estate projects. X, an unrelated party, desires to 
acquire undeveloped land owned by PRS, which has a value of $95x and a 
basis of $5x. X expects to hold the land indefinitely after its 
acquisition. Pursuant to a plan a principal purpose of which is to 
permit X to acquire and hold the land but nevertheless to recover for 
tax purposes a substantial portion of the purchase price for the land, X 
contributes $100x to PRS for an interest therein. Subsequently (at a 
time when the value of the partnership's assets have not materially 
changed), PRS distributes to X in liquidation of its interest in PRS the 
land and another asset with a value and basis to PRS of $5x. The second 
asset is an insignificant part of the economic transaction but is 
important to achieve the desired tax results. Under section 732 (b) and 
(c), X's $100x basis in its partnership interest is allocated between 
the assets distributed to it in proportion to their bases to PRS, or 
$50x each. Thereafter, X plans to sell the second asset for its value of 
$5x, recognizing a loss of $45x. In this manner, X will, in effect, 
recover a substantial portion of the purchase price of the land almost 
immediately. In selecting the assets to be distributed to X, the

[[Page 288]]

partners had a principal purpose to take advantage of the fact that X's 
basis in the assets will be determined under section 732 (b) and (c), 
thus, in effect, shifting a portion of X's basis economically allocable 
to the land that X intends to retain to an inconsequential asset that X 
intends to dispose of quickly. This shift provides a federal tax timing 
advantage to X, with no offsetting detriment to any of PRS's other 
partners.
    (ii) Although section 732 recognizes that basis distortions can 
occur in certain situations, which may produce tax results that do not 
satisfy the proper reflection of income standard of paragraph (a)(3) of 
this section, the provision is intended only to provide ancillary, 
simplifying tax results for bona fide partnership transactions that are 
engaged in for substantial business purposes. Section 732 is not 
intended to serve as the basis for plans or arrangements in which 
inconsequential or immaterial assets are included in the distribution 
with a principal purpose of obtaining substantially favorable tax 
results by virtue of the statute's simplifying rules. The transaction 
does not properly reflect X's income due to the basis distortions caused 
by the distribution that result in shifting a significant portion of X's 
basis to this inconsequential asset. Moreover, the proper reflection of 
income standard contained in paragraph (a)(3) of this section is not 
treated as satisfied, because, taking into account all the facts and 
circumstances, the application of section 732 to this arrangement, and 
the ultimate tax consequences that would thereby result, were not 
clearly contemplated by that provision of subchapter K. In addition, by 
using a partnership (if respected), the partners' aggregate federal tax 
liability would be substantially less than had they owned the 
partnership's assets directly (see paragraph (c)(1) of this section). On 
these facts, PRS has been formed and availed of with a principal purpose 
to reduce the taxpayers' aggregate federal tax liability in a manner 
that is inconsistent with the intent of subchapter K. Therefore (in 
addition to possibly challenging the transaction under applicable 
judicial principles and statutory authorities, such as the disguised 
sale rules under section 707, see paragraph (h) of this section), the 
Commissioner can recast the transaction as appropriate under paragraph 
(b) of this section.

    (e) Abuse of entity treatment--(1) General rule. The Commissioner 
can treat a partnership as an aggregate of its partners in whole or in 
part as appropriate to carry out the purpose of any provision of the 
Internal Revenue Code or the regulations promulgated thereunder.
    (2) Clearly contemplated entity treatment. Paragraph (e)(1) of this 
section does not apply to the extent that--
    (i) A provision of the Internal Revenue Code or the regulations 
promulgated thereunder prescribes the treatment of a partnership as an 
entity, in whole or in part, and
    (ii) That treatment and the ultimate tax results, taking into 
account all the relevant facts and circumstances, are clearly 
contemplated by that provision.
    (f) Examples. The following examples illustrate the principles of 
paragraph (e) of this section. The examples set forth below do not 
delineate the boundaries of either permissible or impermissible types of 
transactions. Further, the addition of any facts or circumstances that 
are not specifically set forth in an example (or the deletion of any 
facts or circumstances) may alter the outcome of the transaction 
described in the example. Unless otherwise indicated, parties to the 
transactions are not related to one another.

    Example 1. Aggregate treatment of partnership appropriate to carry 
out purpose of section 163(e)(5). (i) Corporations X and Y are partners 
in partnership PRS, which for several years has engaged in substantial 
bona fide business activities. As part of these business activities, PRS 
issues certain high yield discount obligations to an unrelated third 
party. Section 163(e)(5) defers (and in certain circumstances disallows) 
the interest deductions on this type of obligation if issued by a 
corporation. PRS, X, and Y take the position that, because PRS is a 
partnership and not a corporation, section 163(e)(5) is not applicable.
    (ii) Section 163(e)(5) does not prescribe the treatment of a 
partnership as an entity for purposes of that section. The purpose of 
section 163(e)(5) is to limit corporate-level interest deductions on 
certain obligations. The treatment of PRS as an entity could result in a 
partnership with corporate partners issuing those obligations and 
thereby circumventing the purpose of section 163(e)(5), because the 
corporate partner would deduct its distributive share of the interest on 
obligations that would have been deferred until paid or disallowed had 
the corporation issued its share of the obligation directly. Thus, under 
paragraph (e)(1) of this section, PRS is properly treated as an 
aggregate of its partners for purposes of applying section 163(e)(5) 
(regardless of whether any party had a tax avoidance purpose in having 
PRS issue the

[[Page 289]]

obligation). Each partner of PRS will therefore be treated as issuing 
its share of the obligations for purposes of determining the 
deductibility of its distributive share of any interest on the 
obligations. See also section 163(i)(5)(B).
    Example 2. Aggregate treatment of partnership appropriate to carry 
out purpose of section 1059. (i) Corporations X and Y are partners in 
partnership PRS, which for several years has engaged in substantial bona 
fide business activities. As part of these business activities, PRS 
purchases 50 shares of Corporation Z common stock. Six months later, 
Corporation Z announces an extraordinary dividend (within the meaning of 
section 1059). Section 1059(a) generally provides that if any 
corporation receives an extraordinary dividend with respect to any share 
of stock and the corporation has not held the stock for more than two 
years before the dividend announcement date, the basis in the stock held 
by the corporation is reduced by the nontaxed portion of the dividend. 
PRS, X, and Y take the position that section 1059(a) is not applicable 
because PRS is a partnership and not a corporation.
    (ii) Section 1059(a) does not prescribe the treatment of a 
partnership as an entity for purposes of that section. The purpose of 
section 1059(a) is to limit the benefits of the dividends received 
deduction with respect to extraordinary dividends. The treatment of PRS 
as an entity could result in corporate partners in the partnership 
receiving dividends through partnerships in circumvention of the intent 
of section 1059. Thus, under paragraph (e)(1) of this section, PRS is 
properly treated as an aggregate of its partners for purposes of 
applying section 1059 (regardless of whether any party had a tax 
avoidance purpose in acquiring the Z stock through PRS). Each partner of 
PRS will therefore be treated as owning its share of the stock. 
Accordingly, PRS must make appropriate adjustments to the basis of the 
Corporation Z stock, and the partners must also make adjustments to the 
basis in their respective interests in PRS under section 705(a)(2)(B). 
See also section 1059(g)(1).
    Example 3. Prescribed entity treatment of partnership; determination 
of CFC status clearly contemplated. (i) X, a domestic corporation, and 
Y, a foreign corporation, intend to conduct a joint venture in foreign 
Country A. They form PRS, a bona fide domestic general partnership in 
which X owns a 40% interest and Y owns a 60% interest. PRS is properly 
classified as a partnership under Secs. 301.7701-2 and 301.7701-3. PRS 
holds 100% of the voting stock of Z, a Country A entity that is 
classified as an association taxable as a corporation for federal tax 
purposes under Sec. 301.7701-2. Z conducts its business operations in 
Country A. By investing in Z through a domestic partnership, X seeks to 
obtain the benefit of the look-through rules of section 904(d)(3) and, 
as a result, maximize its ability to claim credits for its proper share 
of Country A taxes expected to be incurred by Z.
    (ii) Pursuant to sections 957(c) and 7701(a)(30), PRS is a United 
States person. Therefore, because it owns 10% or more of the voting 
stock of Z, PRS satisfies the definition of a U.S. shareholder under 
section 951(b). Under section 957(a), Z is a controlled foreign 
corporation (CFC) because more than 50% of the voting power or value of 
its stock is owned by PRS. Consequently, under section 904(d)(3), X 
qualifies for look-through treatment in computing its credit for foreign 
taxes paid or accrued by Z. In contrast, if X and Y owned their 
interests in Z directly, Z would not be a CFC because only 40% of its 
stock would be owned by U.S. shareholders. X's credit for foreign taxes 
paid or accrued by Z in that case would be subject to a separate foreign 
tax credit limitation for dividends from Z, a noncontrolled section 902 
corporation. See section 904(d)(1)(E) and Sec. 1.904-4(g).
    (iii) Sections 957(c) and 7701(a)(30) prescribe the treatment of a 
domestic partnership as an entity for purposes of defining a U.S. 
shareholder, and thus, for purposes of determining whether a foreign 
corporation is a CFC. The CFC rules prevent the deferral by U.S. 
shareholders of U.S. taxation of certain earnings of the CFC and reduce 
disparities that otherwise might occur between the amount of income 
subject to a particular foreign tax credit limitation when a taxpayer 
earns income abroad directly rather than indirectly through a CFC. The 
application of the look-through rules for foreign tax credit purposes is 
appropriately tied to CFC status. See sections 904(d)(2)(E) and 
904(d)(3). This analysis confirms that Congress clearly contemplated 
that taxpayers could use a bona fide domestic partnership to subject 
themselves to the CFC regime, and the resulting application of the look-
through rules of section 904(d)(3). Accordingly, under paragraph (e) of 
this section, the Commissioner cannot treat PRS as an aggregate of its 
partners for purposes of determining X's foreign tax credit limitation.

    (g) Effective date. Paragraphs (a), (b), (c), and (d) of this 
section are effective for all transactions involving a partnership that 
occur on or after May 12, 1994. Paragraphs (e) and (f) of this section 
are effective for all transactions involving a partnership that occur on 
or after December 29, 1994.
    (h) Scope and application. This section applies solely with respect 
to taxes under subtitle A of the Internal Revenue Code, and for purposes 
of this section, any reference to a federal tax is

[[Page 290]]

limited to any tax imposed under subtitle A of the Internal Revenue 
Code.
    (i) Application of nonstatutory principles and other statutory 
authorities. The Commissioner can continue to assert and to rely upon 
applicable nonstatutory principles and other statutory and regulatory 
authorities to challenge transactions. This section does not limit the 
applicability of those principles and authorities.

[T.D. 8588, 60 FR 27, Jan. 3, 1995; T.D. 8588, 60 FR 9776, 9777, Feb. 
22, 1995, as amended by T.D. 8592, 60 FR 18741, April 13, 1995]



Sec. 1.702-1   Income and credits of partner.

    (a) General rule. Each partner is required to take into account 
separately in his return his distributive share, whether or not 
distributed, of each class or item of partnership income, gain, loss, 
deduction, or credit described in subparagraphs (1) through (9) of this 
paragraph. (For the taxable year in which a partner includes his 
distributive share of partnership taxable income, see section 706(a) and 
Sec. 1.706-1(a). Such distributive share shall be determined as provided 
in section 704 and Sec. 1.704-1.) Accordingly, in determining his income 
tax:
    (1) Each partner shall take into account, as part of his gains and 
losses from sales or exchanges of capital assets held for not more than 
1 year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977), his distributive share of the combined 
net amount of such gains and losses of the partnership.
    (2) Each partner shall take into account, as part of his gains and 
losses from sales or exchanges of capital assets held for more than 1 
year (6 months for taxable years beginning before 1977; 9 months for 
taxable years beginning in 1977), his distributive share of the combined 
net amount of such gains and losses of the partnership.
    (3) Each partner shall take into account, as part of his gains and 
losses from sales or exchanges of property described in section 1231 
(relating to property used in the trade or business and involuntary 
conversions), his distributive share of the combined net amount of such 
gains and losses of the partnership. The partnership shall not combine 
such items with items set forth in subparagraph (1) or (2) of this 
paragraph.
    (4) Each partner shall take into account, as part of the charitable 
contributions paid by him, his distributive share of each class of 
charitable contributions paid by the partnership within the 
partnership's taxable year. Section 170 determines the extent to which 
such amount may be allowed as a deduction to the partner. For the 
definition of the term ``charitable contribution'', see section 170(c).
    (5) Each partner shall take into account, as part of the dividends 
received by him from domestic corporations, his distributive share of 
dividends received by the partnership, with respect to which the partner 
is entitled to a credit under section 34 (for dividends received on or 
before December 31, 1964), an exclusion under section 116, or a 
deduction under part VIII, subchapter B, chapter 1 of the Code.
    (6) Each partner shall take into account, as part of his taxes 
described in section 901 which have been paid or accrued to foreign 
countries or to possessions of the United States, his distributive share 
of such taxes which have been paid or accrued by the partnership, 
according to its method of treating such taxes. A partner may elect to 
treat his total amount of such taxes, including his distributive share 
of such taxes of the partnership, as a deduction under section 164 or as 
a credit under section 901, subject to the provisions of sections 901 
through 905.
    (7) Each partner shall take into account, as part of the partially 
tax-exempt interest received by him on obligations of the United States 
or on obligations of instrumentalities of the United States, as 
described in section 35 or section 242, his distributive share of such 
partially tax-exempt interest received by the partnership. However, if 
the partnership elects to amortize premiums on bonds as provided in 
section 171, the amount received on such obligations by the partnership 
shall be reduced by the amortizable bond premium applicable to such 
obligations as provided in section 171(a)(3).

[[Page 291]]

    (8)(i) Each partner shall take into account separately, as part of 
any class of income, gain, loss, deduction, or credit, his distributive 
share of the following items: Recoveries of bad debts, prior taxes, and 
delinquency amounts (section 111); gains and losses from wagering 
transactions (section 165(d)); soil and water conservation expenditures 
(section 175); nonbusiness expenses as described in section 212; 
medical, dental, etc., expenses (section 213); expenses for care of 
certain dependents (section 214); alimony, etc., payments (section 215); 
amounts representing taxes and interest paid to cooperative housing 
corporations (section 216); intangible drilling and developments costs 
(section 263(c)); pre-1970 exploration expenditures (section 615); 
certain mining exploration expenditures (section 617); income, gain, or 
loss to the partnership under section 751(b); and any items of income, 
gain, loss, deduction, or credit subject to a special allocation under 
the partnership agreement which differs from the allocation of 
partnership taxable income or loss generally.
    (ii) Each partner must also take into account separately his 
distributive share of any partnership item which if separately taken 
into account by any partner would result in an income tax liability for 
that partner different from that which would result if that partner did 
not take the item into account separately. Thus, if any partner would 
qualify for the retirement income credit under section 37 if the 
partnership pensions and annuities, interest, rents, dividends, and 
earned income were separately stated, such items must be separately 
stated for all partners. Under section 911(a), if any partner is a bona 
fide resident of a foreign country who may exclude from his gross income 
the part of his distributive share which qualifies as earned income as 
defined in section 911(b), the earned income of the partnership for all 
partners must be separately stated. Similarly, all relevant items of 
income or deduction of the partnership must be separately stated for all 
partners in determining the applicability of section 270 (relating to 
``hobby losses'') and the recomputation of tax thereunder for any 
partner.
    (iii) Each partner shall aggregate the amount of his separate 
deductions or exclusions and his distributive share of partnership 
deductions or exclusions separately stated in determining the amount 
allowable to him of any deduction or exclusion under subtitle A of the 
Code as to which a limitation is imposed. For example, partner A has 
individual domestic exploration expenditures of $300,000. He is also a 
member of the AB partnership which in 1971 in its first year of 
operation has foreign exploration expenditures of $400,000. A's 
distributable share of this item is $200,000. However, the total amount 
of his distributable share that A can deduct as exploration expenditures 
under section 617(a) is limited to $100,000 in view of the limitation 
provided in section 617(h). Therefore, the excess of $100,000 ($200,000 
minus $100,000) is not deductible by A.
    (9) Each partner shall also take into account separately his 
distributive share of the taxable income or loss of the partnership, 
exclusive of items requiring separate computations under subparagraphs 
(1) through (8) of this paragraph. For limitation on allowance of a 
partner's distributive share of partnership losses, see section 704(d) 
and paragraph (d) of Sec. 1.704-1.
    (b) Character of items constituting distributive share. The 
character in the hands of a partner of any item of income, gain, loss, 
deduction, or credit described in section 702(a)(1) through (8) shall be 
determined as if such item were realized directly from the source from 
which realized by the partnership or incurred in the same manner as 
incurred by the partnership. For example, a partner's distributive share 
of gain from the sale of depreciable property used in the trade or 
business of the partnership shall be considered as gain from the sale of 
such depreciable property in the hands of the partner. Similarly, a 
partner's distributive share of partnership ``hobby losses'' (section 
270) or his distributive share of partnership charitable contributions 
to organizations qualifying under section 170(b)(1)(A) retains such 
character in the hands of the partner.
    (c) Gross income of a partner. (1) Where it is necessary to 
determine the

[[Page 292]]

amount or character of the gross income of a partner, his gross income 
shall include the partner's distributive share of the gross income of 
the partnership, that is, the amount of gross income of the partnership 
from which was derived the partner's distributive share of partnership 
taxable income or loss (including items described in section 702(a)(1) 
through (8)). For example, a partner is required to include his 
distributive share of partnership gross income:
    (i) In computing his gross income for the purpose of determining the 
necessity of filing a return (section 6012 (a));
    (ii) In determining the application of the provisions permitting the 
spreading of income for services rendered over a 36-month period 
(section 1301, as in effect for taxable years beginning before January 
1, 1964);
    (iii) In computing the amount of gross income received from sources 
within possessions of the United States (section 931); and
    (iv) In determining a partner's ``gross income from farming'' 
(sections 175 and 6073).
    (2) In determining the applicability of the 6-year period of 
limitation on assessment and collection provided in section 6501(e) 
(relating to omission of more than 25 percent of gross income), a 
partner's gross income includes his distributive share of partnership 
gross income (as described in section 6501(e)(1)(A)(i)). In this 
respect, the amount of partnership gross income from which was derived 
the partner's distributive share of any item of partnership income, 
gain, loss, deduction, or credit (as included or disclosed in the 
partner's return) is considered as an amount of gross income stated in 
the partner's return for the purposes of section 6501(e). For example, 
A, who is entitled to one-fourth of the profits of the ABCD partnership, 
which has $10,000 gross income and $2,000 taxable income, reports only 
$300 as his distributive share of partnership profits. A should have 
shown $500 as his distributive share of profits, which amount was 
derived from $2,500 of partnership gross income. However, since A 
included only $300 on his return without explaining in the return the 
difference of $200, he is regarded as having stated in his return only 
$1,500 ($300/$500 of $2,500) as gross income from the partnership.
    (d) Partners in community property States. If separate returns are 
made by a husband and wife domiciled in a community property State, and 
only one spouse is a member of the partnership, the part of his or her 
distributive share of any item or items listed in paragraph (a) (1) 
through (9) of this section which is community property, or which is 
derived from community property, should be reported by the husband and 
wife in equal proportions.
    (e) Special rules on requirement to separately state meal, travel, 
and entertainment expenses. Each partner shall take into account 
separately his or her distributive share of meal, travel, and 
entertainment expenses paid or incurred after December 31, 1986, by 
partnerships that have taxable years beginning before January 1, 1987, 
and ending with or within partner's taxable years beginning on or after 
January 1, 1987. In addition, with respect to skybox rentals under 
section 274 (1) (2), each partner shall take into account separately his 
or her distributive share of rents paid or incurred after December 31, 
1986, by partnerships that have taxable years beginning before January 
1, 1989, and ending with or within partners' taxable years beginning on 
or after January 1, 1987.
    (f) Cross--references. For special rules in accordance with the 
principles of section 702 applicable solely for the purpose of the tax 
imposed by section 56 (relating to the minimum tax for tax preferences) 
see Sec. 1.58-2(a). In the case of a disposition of an oil or gas 
property by the partnership, see the rules contained in section 
613A(c)(7)(D) and Sec. 1.613A-3(e).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6605, 27 FR 
8097, Aug. 15, 1962; T.D. 6777, 29 FR 17809, Dec. 16, 1964; T.D. 6885, 
31 FR 7803, June 2, 1966; T.D. 7192, 37 FR 12949, June 30, 1972; T.D. 
7564, 43 FR 40496, Sept. 12, 1978; T.D. 7728, 45 FR 72650, Nov. 3, 1980; 
T.D. 8247, 54 FR 13680, Apr. 5, 1989; T.D. 8348, 56 FR 21952, May 13, 
1991; 57 FR 4913, Feb. 10, 1992]



Sec. 1.702-2  Net operating loss deduction of partner.

    For the purpose of determining a net operating loss deduction under 
section

[[Page 293]]

172, a partner shall take into account his distributive share of items 
of income, gain, loss, deduction, or credit of the partnership. The 
character of any such item shall be determined as if such item were 
realized directly from the source from which realized by the 
partnership, or incurred in the same manner as incurred by the 
partnership. See section 702(b) and paragraph (b) of Sec. 1.702-1. To 
the extent necessary to determine the allowance under section 172(d)(4) 
of the nonbusiness deductions of a partner (arising from both 
partnership and nonpartnership sources), the partner shall separately 
take into account his distributive share of the deductions of the 
partnership which are not attributable to a trade or business and 
combine such amount with his nonbusiness deductions from nonpartnership 
sources. Such partner shall also separately take into account his 
distributive share of the gross income of the partnership not derived 
from a trade or business and combine such amount with his nonbusiness 
income from nonpartnership sources. See section 172 and the regulations 
thereunder.



Sec. 1.702-3T  4-year spread (temporary).

    (a) Applicability. This section applies to a partner in a 
partnership if--
    (1) The partnership is required by section 806 of the Tax Reform Act 
of 1986 (the 1986 Act), Pub. L. 99-514, 100 Stat. 2362, to change its 
taxable year for the first taxable year beginning after December 31, 
1986 (partnership's year of change); and
    (2) As a result of such change in taxable year, items from more than 
one taxable year of the partnership would, but for the provisions of 
this section, be included in the taxable year of the partner with or 
within which the partnership's year of change ends.
    (b) Partner's treatment of items from the partnership's year of 
change--(1) In general. Except as provided in paragraph (c) of this 
section, if a partner's share of ``income items'' exceeds the partner's 
share of ``expense items,'' the partner's share of each and every income 
and expense item shall be taken into account ratably (and retain its 
character) over the partner's first 4 taxable years beginning with the 
partner's taxable year with or within which the partnership's year of 
change ends.
    (2) Definitions--(i) Income items. For purposes of this section, the 
term income items means the sum of--
    (A) The partner's distributive share of taxable income (exclusive of 
separately stated items) from the partnership's year of change,
    (B) The partner's distributive share of all separately stated income 
or gain items from the partnership's year of change, and
    (C) Any amount includible in the partner's income under section 
707(c) on account of payments during the partnership's year of change.
    (ii) Expense items. For purposes of this section, the term expense 
items means the sum of--
    (A) The partner's distributive share of taxable loss (exclusive of 
separately stated items) from the partnership's year of change, and
    (B) The partner's distributive share of all separately stated items 
of loss or deduction from the partnership's year of change.
    (c) Electing out of 4-year spread. A partner may elect out of the 
rules of paragraph (b) of this section by meeting the requirements of 
Sec. 301.9100-7T of this chapter (temporary regulations relating to 
elections under the Tax Reform Act of 1986).
    (d) Special rules for a partner that is a partnership or S 
corporation--(1) In general. Except as provided in paragraph (d)(2) of 
this section, a partner that is a partnership or S corporation may, if 
otherwise eligible, use the 4-year spread (with respect to partnership 
interests owned by the partner) described in this section.
    (2) Certain partners prohibited from using 4-year spread--(i) In 
general. Except as provided in paragraph (d)(2)(ii) of this section, a 
partner that is a partnership or S corporation may not use the 4-year 
spread (with respect to partnership interests owned by the partner) if 
such partner is also changing its taxable year pursuant to section 806 
of the 1986 Act.
    (ii) Exception. If a partner's year of change does not include any 
income or expense items with respect to the partnership's year of 
change, such partner may, if otherwise eligible, use the 4-

[[Page 294]]

year spread (with respect to such partnership interest) described in 
this section even though the partner is a partnership or S corporation. 
See examples 13 and 14 in paragraph (h) of this section.
    (e) Basis of partner's interest. The basis of a partner's interest 
in a partnership shall be determined as if the partner elected not to 
spread the partnership items over 4 years, regardless of whether such 
election was in fact made. Thus, for example, if a partner is eligible 
for the 4-year spread and does not elect out of the 4-year spread 
pursuant to paragraph (c) of this section, the partner's basis in the 
partnership interest will be increased in the first year of the 4-year 
spread period by an amount equal to the excess of the income items over 
the expense items. However, the partner's basis will not be increased 
again, with respect to the unamortized income and expense items, as they 
are amortized over the 4-year spread period.
    (f) Effect on other provisions of the Code. Except as provided in 
paragraph (e) of this section, determinations with respect to a partner, 
for purposes of other provisions of the Code, must be made with regard 
to the manner in which partnership items are taken into account under 
the rules of this section. Thus, for example, a partner who does not 
elect out of the 4-year spread must take into account, for purposes of 
determining net earnings from self-employment under section 1402(a) for 
a taxable year, only the ratable portion of partnership items for that 
taxable year.
    (g) Treatment of dispositions--(1) In general. If a partnership 
interest is disposed of before the last taxable year in the 4-year 
spread period, unamortized income and expense items that are 
attributable to the interest disposed of and that would be taken into 
account by the partner for subsequent taxable years in the 4-year spread 
period shall be taken into account by the partner as determined under 
paragraph (g)(2) of this section. For purposes of this section, the term 
disposed of means any transfer, including (but not limited to) transfers 
by sale, exchange, gift, and by reason of death.
    (2) Year unamortized items taken into account--(i) In general. If, 
at the end of a partner's taxable year, the fraction determined under 
paragraph (g)(2)(ii) of this section is--
    (A) Greater than \2/3\, the partner must continue to take the 
unamortized income and expense items into account ratably over the 4-
year spread period;
    (B) Greater than \1/3\ but less than or equal to \2/3\, the partner 
must, in addition to its ratable amortization, take into account in such 
year 50 percent of the income and expense items that would otherwise be 
unamortized at the end of such year (however, this paragraph 
(g)(2)(i)(B) is only applied once with respect to a partner's interest 
in a particular partnership); or
    (C) Less than or equal to \1/3\, the partner must take into account 
the entire balance of unamortized income and expense items in such year.
    (ii) Determination of fraction. For purposes of paragraph (g)(2)(i) 
of this section, the numerator of the fraction is the partner's 
proportionate interest in the partnership at the end of the partner's 
taxable year and the denominator is the partner's proportionate interest 
in the partnership as of the last day of the partnership's year of 
change.
    (h) Examples. The provisions of this section may be illustrated by 
the following examples.

    Example 1. Assume that P1, a partnership with a taxable year ending 
September 30, is required by the 1986 Act to change its taxable year to 
a calendar year. All of the partners of P1 are individual taxpayers 
reporting on a calendar year. P1 is required to change to a calendar 
year for its taxable year beginning October 1, 1987, and to file a 
return for the short taxable year ending December 31, 1987. Based on the 
above facts, the partners of P1 are required to include the items from 
more than one taxable year of P1 in income for their 1987 taxable year. 
Thus, under paragraph (b) of this section, if a partner's share of 
income items exceeds the partner's share of expense items, the partner's 
share of each and every income and expense item shall be taken into 
account ratably by such partner in each of the partner's first four 
taxable years' beginning with the partner's 1987 taxable year, unless 
such partner elects under paragraph (c) of this section to include all 
such amounts in his 1987 taxable year.
    Example 2. Assume the same facts as in example 1, except P1 is a 
personal service corporation with all of its employee-owners reporting 
on a calendar year. Although P1 is

[[Page 295]]

required to change to a calendar year for its taxable year beginning 
October 1, 1987, neither P1 nor its employee-owners obtain the benefits 
of a 4-year spread. Pursuant to section 806(e)(2)(C) of the 1986 Act, 
the 4-year spread provision is only applicable to short taxable years of 
partnerships and S corporations required to change their taxable year 
under the 1986 Act.
    Example 3. Assume the same facts as example 1 and that I is one of 
the individual partners of P1. Further assume that I's distributive 
share of P1's taxable income for the short taxable year ended December 
31, 1987 (i.e., P1's year of change), is $10,000. In addition, I has 
$8,000 of separately stated expense from P1's year of change. Since I's 
income items (i.e., $10,000 of taxable income) exceed I's expense items 
(i.e., $8,000 of separately stated expense) attributable to P1's year of 
change, I is eligible for the 4-year spread provided by this section. If 
I does not elect out of the 4-year spread, I will recognize $2,500 of 
taxable income and $2,000 of separately stated expense in his 1987 
calendar year return. Assuming I does not dispose of his partnership 
interest in P1 by December 31, 1989, the remaining $7,500 of taxable 
income and $6,000 of separately stated expense will be amortized (and 
retain its character) over I's next three taxable years (i.e., 1988, 
1989 and 1990).
    Example 4. Assume the same facts as example 3, except that I 
disposes of his entire interest in P1 during 1988. Pursuant to paragraph 
(g) of this section, I would recognize $7,500 of taxable income and 
$6,000 of separately stated expense in his 1988 calendar year return.
    Example 5. Assume the same facts as in example 3, except that I 
disposes of 50 percent of his interest in P1 during 1989. Pursuant to 
paragraph (g) of this section, I would recognize $3,750 of taxable 
income in his 1989 calendar year return ($2,500 ratable portion for 1989 
plus 50 percent of the $2,500 of income items that would otherwise be 
unamortized at the end of 1989). I would also recognize $3,000 of 
separately stated expense items in 1989 ($2,000 ratable portion for 1989 
plus 50 percent of the $2,000 of separately stated expense items that 
would otherwise be unamortized at the end of 1989).
    Example 6. Assume the same facts as in example 1, except that X, a 
personal service corporation as defined in section 441(i), is a partner 
of P1. X is a calendar year taxpayer, and thus is not required to change 
its taxable year under the 1986 Act. The same result occurs as in 
example 1 (i.e., unless X elects to the contrary, X is required to 
include one fourth of its share of income and expense items from P1's 
year of change in the first four taxable years of X beginning with the 
1987 taxable year).
    Example 7. Assume the same facts as in example 6, except that X is a 
fiscal year personal service corporation with a taxable year ending 
September 30. X is required under the 1986 Act to change to a calendar 
year for its taxable year beginning October 1, 1987, and to file a 
return for its short year ending December 31, 1987. Based on the above 
facts, X is not required to include the items from more than one taxable 
year of P1 in any one taxable year of X. Thus, the provisions of this 
section do not apply to X, and X is required to include the full amount 
of income and expense items from P1's year of change in X's taxable 
income for X's short year ending December 31. Under section 443 of the 
Code, X is required to annualize the taxable income for its short year 
ending December 31, 1987.
    Example 8. Assume that P2 is a partnership with a taxable year 
ending September 30. Under the 1986 Act, P2 would have been required to 
change its taxable year to a calendar year, effective for the taxable 
year beginning October 1, 1987. However, P2 properly changed its taxable 
year to a calendar year for the year beginning October 1, 1986, and 
filed a return for the short period ending December 31, 1986. The 
provisions of the 1986 Act do not apply to P2 because the short year 
ending December 31, 1986, was not required by the amendments made by 
section 806 of the 1986 Act. Thus, the partners of P2 are required to 
take all items of income and expense for the short taxable year ending 
December 31, 1986, into account for the taxable year with or within 
which such short year ends.
    Example 9. Assume that P3 is a partnership with a taxable year 
ending March 31 and I, a calendar year individual, is a partner in P3. 
Under the 1986 Act, P3 would have been required to change its taxable 
year to a calendar year. However, under Rev. Proc. 87-32, P3 establishes 
and changes to a natural business year beginning with the taxable year 
ending June 30, 1987. Thus, P3 is required to change its taxable year 
under section 806 of the 1986 Act, and I is required to include items 
from more than one taxable year of P3 in one of her taxable years. 
Furthermore, I's share of P3's income items exceeds her share of P3's 
expense items for the short period April 1, 1987 through June 30, 1987. 
Accordingly, under this section, unless I elects to the contrary, I is 
required to take one fourth of her share of items of income and expense 
from P3's short taxable year ending June 30, 1987 into account for her 
taxable year ending December 31, 1987.
    Example 10. Assume that P4 is a partnership with a taxable year 
ending March 31. Y, a C corporation, owns a 51 percent interest in the 
profits and capital of P4. Y reports its income on the basis of a 
taxable year ending March 31. P4 establishes and changes to a natural 
business year beginning with the taxable year ending June 30, 1987, 
under Rev. Proc. 87-32. Under the above facts, P4 is not required to 
change its taxable year because

[[Page 296]]

its March 31 taxable year was the taxable year of Y, the partner owning 
a majority of the partnership's profits and capital. Therefore, the 
remaining partners of P4 owning 49 percent of the profits and capital 
are not permitted the 4-year spread of the items of income and expense 
with respect to the short year, even though they may be required to 
include their distributive share of P4's items from more than one 
taxable year in one of their years.
    Example 11. Assume that X and Y are C corporations with taxable 
years ending June 30. Each owns a 50-percent interest in the profits and 
capital of partnership P5. P5 has a taxable year ending March 31. Assume 
that P5 cannot establish a business purpose in order to retain a taxable 
year ending March 31, and thus P5 must change to a June 30 taxable year, 
the taxable year of its partners. Furthermore, assume that X's share of 
P5's income items exceeds its share of P5's expense items for P5's short 
taxable year ending June 30, 1987. Unless X elects out of the 4-year 
spread, the taxable year ending June 30, 1987, is the first of the four 
taxable years in which X must take into account its share of the items 
of income and expense resulting from P5's short taxable year ending June 
30, 1987.
    Example 12. Assume that I, an individual who reports income on the 
basis of the calendar year, is a partner in two partnerships, P6 and P7. 
Both partnerships have a taxable year ending September 30. Neither 
partnership can establish a business purpose for retaining its taxable 
year. Consequently, each partnership will change its taxable year to 
December 31, for the taxable year beginning October 1, 1987. The 
election to avoid a 4-year spread is made at the partner level; in 
addition, a partner may make such elections on a partnership-by-
partnership basis. Thus, assuming I is eligible to obtain the 4-year 
spread with respect to income and expense items from partnerships P6 and 
P7, I may use the 4-year spread with respect to items from P6, while not 
using the 4-year spread with respect to items from P7.
    Example 13. I, an individual taxpayer using a calendar year, owns an 
interest in P8, a partnership using a taxable year ending June 30. 
Furthermore, P8 owns an interest in P9, a partnership with a taxable 
year ending March 31. Under section 806 of the 1986 Act, P8 will be 
required to change to a taxable year ending December 31, while P9 will 
be required to change to a taxable year ending June 30. As a result, 
P8's year of change will be July 1 through December 31, 1987, while P9's 
year of change will be from April 1 through June 30, 1987. Since P9's 
year of change does not end with or within P8's year of change, 
paragraph (d)(2) of this section does not prevent P8 from obtaining a 4-
year spread with respect to its interest in P9.
    Example 14. The facts are the same as in example 13, except that P9 
has a taxable year ending September 30, and under the 1986 Act P9 is 
required to change to a taxable year ending December 31. Therefore, P9's 
year of change will be from October 1, 1987 through December 31, 1987. 
Although P8's year of change from July 1, 1987 through December 31, 1987 
includes two taxable years of P9 (i.e., October 1, 1986 through 
September 30, 1987 and October 1, 1987 through December 31, 1987), 
paragraph (d)(2) of this section prohibits P8 from using the 4-year 
spread with respect to its interest in P9, because P9's year of change 
ends with or within P8's year of change.

[T.D. 8167, 52 FR 48530, Dec. 23, 1987, as amended by T.D. 8435, 57 FR 
43896, Sept. 23, 1992]



Sec. 1.703-1   Partnership computations.

    (a) Income and deductions. (1) The taxable income of a partnership 
shall be computed in the same manner as the taxable income of an 
individual, except as otherwise provided in this section. A partnership 
is required to state separately in its return the items described in 
section 702(a)(1) through (7) and, in addition, to attach to its return 
a statement setting forth separately those items described in section 
702(a)(8) which the partner is required to take into account separately 
in determining his income tax. See paragraph (a)(8) of Sec. 1.702-1. The 
partnership is further required to compute and to state separately in 
its return:
    (i) As taxable income under section 702(a)(9), the total of all 
other items of gross income (not separately stated) over the total of 
all other allowable deductions (not separately stated), or
    (ii) As loss under section 702(a)(9), the total of all other 
allowable deductions (not separately stated) over the total of all other 
items of gross income (not separately stated).

The taxable income or loss so computed shall be accounted for by the 
partners in accordance with their partnership agreement.
    (2) The partnership is not allowed the following deductions:
    (i) The standard deduction provided in section 141.
    (ii) The deduction for personal exemptions provided in section 151.

[[Page 297]]

    (iii) The deduction provided in section 164(a) for taxes, described 
in section 901, paid or accrued to foreign countries or possessions of 
the United States. Each partner's distributive share of such taxes shall 
be accounted for separately by him as provided in section 702(a)(6).
    (iv) The deduction for charitable contributions provided in section 
170. Each partner is considered as having paid within his taxable year 
his distributive share of any contribution or gift, payment of which was 
actually made by the partnership within its taxable year ending within 
or with the partner's taxable year. This item shall be accounted for 
separately by the partners as provided in section 702(a)(4). See also 
paragraph (b) of Sec. 1.702-1.
    (v) The net operating loss deduction provided in section 172. See 
Sec. 1.702-2.
    (vi) The additional itemized deductions for individuals provided in 
part VII, subchapter B, chapter 1 of the Code, as follows: Expenses for 
production of income (section 212); medical, dental, etc., expenses 
(section 213); expenses for care of certain dependents (section 214); 
alimony, etc., payments (section 215); and amounts representing taxes 
and interest paid to cooperative housing corporation (section 216). 
However, see paragraph (a)(8) of Sec. 1.702-1.
    (vii) The deduction for depletion under section 611 with respect to 
domestic oil or gas which is produced after December 31, 1974, and to 
which gross income from the property is attributable after such year.
    (viii) The deduction for capital gains provided by section 1202 and 
the deduction for capital loss carryover provided by section 1212.
    (b) Elections of the partnership--(1) General rule. Any elections 
(other than those described in subparagraph (2) of this paragraph) 
affecting the computation of income derived from a partnership shall be 
made by the partnership. For example, elections of methods of 
accounting, of computing depreciation, of treating soil and water 
conservation expenditures, and the option to deduct as expenses 
intangible drilling and development costs, shall be made by the 
partnership and not by the partners separately. All partnership 
elections are applicable to all partners equally, but any election made 
by a partnership shall not apply to any partner's nonpartnership 
interests.
    (2) Exceptions. (i) Each partner shall add his distributive share of 
taxes described in section 901 paid or accrued by the partnership to 
foreign countries or possessions of the United States (according to its 
method of treating such taxes) to any such taxes paid or accrued by him 
(according to his method of treating such taxes), and may elect to use 
the total amount either as a credit against tax or as a deduction from 
income.
    (ii) Each partner shall add his distributive share of expenses 
described in section 615 or section 617 paid or accrued by the 
partnership to any such expenses paid or accrued by him and shall treat 
the total amount according to his method of treating such expenses, 
notwithstanding the treatment of the expenses by the partnership.
    (iii) Each partner who is a nonresident alien individual or a 
foreign corporation shall add his distributive share of income derived 
by the partnership from real property located in the United States, as 
described in section 871(d)(1) or 882(d)(1), to any such income derived 
by him and may elect under Sec. 1.871-10 to treat all such income as 
income which is effectively connected for the taxable year with the 
conduct of a trade or business in the United States.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7192, 37 FR 
12949, June 30, 1972; T.D. 7332, 39 FR 44232, Dec. 23, 1974; T.D. 8348, 
56 FR 21952, May 13, 1991]



Sec. 1.704-1   Partner's distributive share.

    (a) Effect of partnership agreement. A partner's distributive share 
of any item or class of items of income, gain, loss, deduction, or 
credit of the partnership shall be determined by the partnership 
agreement, unless otherwise provided by section 704 and paragraphs (b) 
through (e) of this section. For definition of partnership agreement see 
section 761(c).
    (b) Determination of partner's distributive share--(0) Cross-
references.

------------------------------------------------------------------------
               Heading                              Section             
------------------------------------------------------------------------
Cross-references....................  1.704-1(b)(2)(iv)(d)(2)           
In general..........................  1.704-1(b)(2)(iv)(d)(3)           

[[Page 298]]

                                                                        
    Basic principles................  1.704-1(b)(1)(i)                  
    Effective dates.................  1.704-1(b)(2)(iv)(e)(1)           
    Effect of other sections........  1.704-1(b)(2)(iv)(e)(2)           
    Other possible tax consequences.  1.704-1(b)(1)(iv)                 
    Purported allocations...........  1.704-1(b)(1)(v)                  
    Section 704(c) determinations...  1.704-1(b)(1)(vi)                 
    Bottom line allocations.........  1.704-1(b)(1)(vii)                
Substantial economic effect.........  1.704-1(b)(2)                     
    Two-part analysis...............  1.704-1(b)(2)(i)                  
    Economic effect.................  1.704-1(b)(2)(ii)                 
        Fundamental principles......  1.704-1(b)(2)(ii)(a)              
        Three requirements..........  1.704-1(b)(2)(ii)(b)              
        Obligation to restore         1.704-1(b)(2)(ii)(c)              
         deficit.                                                       
        Alternate test for economic   1.704-1(b)(2)(ii)(d)              
         effect.                                                        
        Partial economic effect.....  1.704-1(b)(2)(ii)(e)              
        Reduction of obligation to    1.704-1(b)(2)(ii)(f)              
         restore.                                                       
        Liquidation defined.........  1.704-1(b)(2)(ii)(g)              
        Partnership agreement         1.704-1(b)(2)(ii)(h)              
         defined.                                                       
        Economic effect equivalence.  1.704-1(b)(2)(ii)(i)              
    Substantiality..................  1.704-1(b)(2)(iii)                
        General rules...............  1.704-1(b)(2)(iii)(a)             
        Shifting tax consequences...  1.704-1(b)(2)(iii)(b)             
        Transitory allocations......  1.704-1(b)(2)(iii)(c)             
Maintenance of capital accounts.....  1.704-1(b)(2)(iv)                 
    In general......................  1.704-1(b)(2)(iv)(a)              
    Basic rules.....................  1.704-1(b)(2)(iv)(b)              
    Treatment of liabilities........  1.704-1(b)(2)(iv)(c)              
    Contributed property............  1.704-1(b)(2)(iv)(d)              
        In general..................  1.704-1(b)(2)(iv)(d)(1)           
        Contribution of promissory    1.704-1(b)(2)(d)(2)               
         notes.                                                         
        Section 704(c)                1.704-1(b)(2)(iv)(3)              
         considerations.                                                
    Distributed property............  1.704-1(b)(2)(iv)(e)              
        In general..................  1.704-1(2)(iv)(e)(1)              
        Distribution of promissory    1.704-1(b)(2)(e)(2)               
         notes.                                                         
    Revaluations of property........  1.704-1(b)(2)(iv)(f)              
    Adjustments to reflect book       1.704-1(b)(2)(iv)(g)              
     value.                                                             
        In general..................  1.704-1(b)(2)(iv)(g)(1)           
        Payables and receivables....  1.704-1(b)(2)(iv)(g)(2)           
        Determining amount of book    1.704-1(b)(2)(iv)(g)(3)           
         items.                                                         
    Determinations of fair market     1.704-1(b)(2)(iv)(h)              
     value.                                                             
    Section 705(a)(2)(B)              1.704-1(b)(2)(iv)(i)              
     expenditures.                                                      
        In general..................  1.704-1(b)(2)(iv)(i)(1)           
        Expenses described in         1.704-1(b)(2)(iv)(i)(2)           
         section 709.                                                   
        Disallowed losses...........  1.704-1(b)(2)(iv)(i)(3)           
    Basis adjustments to section 38   1.704-1(b)(2)(iv)(j)              
     property.                                                          
    Depletion of oil and gas          1.704-1(b)(2)(iv)(k)              
     properties.                                                        
        In general..................  1.704-1(b)(2)(iv)(k)(1)           
        Simulated depletion.........  1.704-1(b)(2)(iv)(k)(2)           
        Actual depletion............  1.704-1(b)(2)(iv)(k)(3)           
        Effect of book values.......  1.704-1(b)(2)(iv)(k)(4)           
    Transfers of partnership          1.704-1(b)(2)(iv)(l)              
     interests.                                                         
    Section 754 elections...........  1.704-1(b)(2)(iv)(m)              
        In general..................  1.704-1(b)(2)(iv)(m)(1)           
        Section 743 adjustments.....  1.704-1(b)(2)(iv)(m)(2)           
        Section 732 adjustments.....  1.704-1(b)(2)(iv)(m)(3)           
        Section 734 adjustments.....  1.704-1(b)(2) iv)(m)(4)           
        Limitations on adjustments..  1.704-1(b)(2) iv)(m)(5)           
    Partnership level                 1.704-1(b)(2)(iv)(n)              
     characterization.                                                  
    Guaranteed payments.............  1.704-1(b)(2)(iv)(o)              
    Minor discrepancies.............  1.704-1(b)(2)(iv)(p)              
    Adjustments where guidance is     1.704-1(b)(2)(iv)(q)              
     lacking.                                                           
    Restatement of capital accounts.  1.704-1(b)(2)(iv)(r)              
    Partner's interest in the         1.704-1(b)(3)                     
     partnership.                                                       
        In general..................  1.704-1(b)(3)(i)                  
        Factors considered..........  1.704-1(b)(3)(ii)                 
        Certain determinations......  1.704-1(b)(3)(iii)                
    Special rules...................  1.704-1(b)(4)                     
        Allocations to reflect        1.704-1(b)(4)(i)                  
         revaluations.                                                  
        Credits.....................  1.704-1(b)(4)(ii)                 
        Excess percentage depletion.  1.704-1(b)(4)(iii)                
        Allocations attributable to   1.704-1(b)(4)(iv)                 
         nonrecourse liabilities.                                       
        Allocations under section     1.704-1(b)(4)(v)                  
         613A(c(7)(D).                                                  
        Amendments to partnership     1.704-1(b)(4)(vi)                 
         agreement.                                                     
        Recapture...................  1.704-1(b)(4)(vii)                
    Examples........................  1.704-1(b)(5)                     
------------------------------------------------------------------------

    (1) In general--(i) Basic principles. Under section 704(b) if a 
partnership agreement does not provide for the allocation of income, 
gain, loss, deduction, or credit (or item thereof) to a partner, or if 
the partnership agreement provides for the allocation of income, gain, 
loss, deduction, or credit (or item thereof) to a partner but such 
allocation does not have substantial economic effect, then the partner's 
distributive share of such income, gain, loss, deduction, or credit (or 
item thereof) shall be determined in accordance with such partner's 
interest in the partnership (taking into account all facts and 
circumstances). If the partnership agreement provides for the allocation 
of income, gain, loss, deduction, or credit (or item thereof) to a 
partner, there are three ways in which such allocation will be respected 
under section 704(b) and this paragraph. First, the allocation can have 
substantial economic effect in accordance with paragraph (b)(2) of this 
section. Second,

[[Page 299]]

taking into account all facts and circumstances, the allocation can be 
in accordance with the partner's interest in the partnership. See 
paragraph (b)(3) of this section. Third, the allocation can be deemed to 
be in accordance with the partner's interest in the partnership pursuant 
to one of the special rules contained in paragraph (b)(4) of this 
section and Sec. 1.704-2. To the extent an allocation under the 
partnership agreement of income, gain, loss, deduction, or credit (or 
item thereof) to a partner does not have substantial economic effect, is 
not in accordance with the partner's interest in the partnership, and is 
not deemed to be in accordance with the partner's interest in the 
partnership, such income, gain, loss, deduction, or credit (or item 
thereof) will be reallocated in accordance with the partner's interest 
in the partnership (determined under paragraph (b)(3) of this section).
    (ii) Effective dates. The provisions of this paragraph are effective 
for partnership taxable years beginning after December 31, 1975. 
However, for partnership taxable years beginning after December 31, 
1975, but before May 1, 1986, (January 1, 1987, in the case of 
allocations of nonrecourse deductions as defined in paragraph 
(b)(4)(iv)(a) of this section) an allocation of income, gain, loss, 
deduction, or credit (or item thereof) to a partner that is not 
respected under this paragraph nevertheless will be respected under 
section 704(b) if such allocation has substantial economic effect or is 
in accordance with the partners' interests in the partnership as those 
terms have been interpreted under the relevant case law, the legislative 
history of section 210(d) of the Tax Reform Act of 1976, and the 
provisions of this paragraph in effect for partnership taxable years 
beginning before May 1, 1986.
    (iii) Effect of other sections. The determination of a partner's 
distributive share of income, gain, loss, deduction, or credit (or item 
thereof) under section 704(b) and this paragraph is not conclusive as to 
the tax treatment of a partner with respect to such distributive share. 
For example, an allocation of loss or deduction to a partner that is 
respected under section 704(b) and this paragraph may not be deductible 
by such partner if the partner lacks the requisite motive for economic 
gain (see, e.g., Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 
1966)), or may be disallowed for that taxable year (and held in 
suspense) if the limitations of section 465 or section 704(d) are 
applicable. Similarly, an allocation that is respected under section 
704(b) and this paragraph nevertheless may be reallocated under other 
provisions, such as section 482, section 704(e)(2), section 706(d) (and 
related assignment of income principles), and paragraph (b)(2)(ii) of 
Sec. 1.751-1. If a partnership has a section 754 election in effect, a 
partner's distributive share of partnership income, gain, loss, or 
deduction may be affected as provided in Sec. 1.743-1 (see paragraph 
(b)(2)(iv)(m)(2) of this section). A deduction that appears to be a 
nonrecourse deduction deemed to be in accordance with the partners' 
interests in the partnership may not be such because purported 
nonrecourse liabilities of the partnership in fact constitute equity 
rather than debt. The examples in paragraph (b)(5) of this section 
concern the validity of allocations under section 704(b) and this 
paragraph and, except as noted, do not address the effect of other 
sections or limitations on such allocations.
    (iv) Other possible tax consequences. Allocations that are respected 
under section 704(b) and this paragraph may give rise to other tax 
consequences, such as those resulting from the application of section 
61, section 83, section 751, section 2501, paragraph (f) of Sec. 1.46-3, 
Sec. 1.47-6, paragraph (b)(1) of Sec. 1.721-1 (and related principles), 
and paragraph (e) of Sec. 1.752-1. The examples in paragraph (b)(5) of 
this section concern the validity of allocations under section 704(b) 
and this paragraph and, except as noted, do not address other tax 
consequences that may result from such allocations.
    (v) Purported allocations. Section 704(b) and this paragraph do not 
apply to a purported allocation if it is made to a person who is not a 
partner of the partnership (see section 7701(a)(2) and paragraph (d) of 
Sec. 301.7701-3) or to a person who is not receiving the purported 
allocation in his capacity as a partner (see section 707(a) and 
paragraph (a) of Sec. 1.707-1).

[[Page 300]]

    (vi) Section 704(c) determinations. Section 704(c) and Sec. 1.704-3 
generally require that if property is contributed by a partner to a 
partnership, the partners' distributive shares of income, gain, loss, 
and deduction, as computed for tax purposes, with respect to the 
property are determined so as to take account of the variation between 
the adjusted tax basis and fair market value of the property. Although 
section 704(b) does not directly determine the partners' distributive 
shares of tax items governed by section 704(c), the partners' 
distributive shares of tax items may be determined under section 704(c) 
and Sec. 1.704-3 (depending on the allocation method chosen by the 
partnership under Sec. 1.704-3) with reference to the partners' 
distributive shares of the corresponding book items, as determined under 
section 704(b) and this paragraph. (See paragraphs (b)(2)(iv)(d) and 
(b)(4)(i) of this section.) See Sec. 1.704-3 for methods of making 
allocations under section 704(c), and Sec. 1.704-3(d)(2) for a special 
rule in determining the amount of book items if the remedial allocation 
method is chosen by the partnership. See also paragraph (b)(5) Example 
(13) (i) of this section.
    (vii) Bottom line allocations. Section 704(b) and this paragraph are 
applicable to allocations of income, gain, loss, deduction, and credit, 
allocations of specific items of income, gain, loss, deduction, and 
credit, and allocations of partnership net or ``bottom line'' taxable 
income and loss. An allocation to a partner of a share of partnership 
net or ``bottom line'' taxable income or loss shall be treated as an 
allocation to such partner of the same share of each item of income, 
gain, loss, and deduction that is taken into account in computing such 
net or ``bottom line'' taxable income or loss. See example 15(i) of 
paragraph (b)(5) of this section.
    (2) Substantial economic effect--(i) Two-part analysis. The 
determination of whether an allocation of income, gain, loss, or 
deduction (or item thereof) to a partner has substantial economic effect 
involves a two-part analysis that is made as of the end of the 
partnership taxable year to which the allocation relates. First, the 
allocation must have economic effect (within the meaning of paragraph 
(b)(2)(ii) of this section). Second, the economic effect of the 
allocation must be substantial (within the meaning of paragraph 
(b)(2)(iii) of this section).
    (ii) Economic effect--(a) Fundamental principles. In order for an 
allocation to have economic effect, it must be consistent with the 
underlying economic arrangement of the partners. This means that in the 
event there is an economic benefit or economic burden that corresponds 
to an allocation, the partner to whom the allocation is made must 
receive such economic benefit or bear such economic burden.
    (b) Three requirements.  Based on the principles contained in 
paragraph (b)(2)(ii)(a) of this section, and except as otherwise 
provided in this paragraph, an allocation of income, gain, loss, or 
deduction (or item thereof) to a partner will have economic effect if, 
and only if, throughout the full term of the partnership, the 
partnership agreement provides--
    (1) For the determination and maintenance of the partners' capital 
accounts in accordance with the rules of paragraph (b)(2)(iv) of this 
section,
    (2) Upon liquidation of the partnership (or any partner's interest 
in the partnership), liquidating distributions are required in all cases 
to be made in accordance with the positive capital account balances of 
the partners, as determined after taking into account all capital 
account adjustments for the partnership taxable year during which such 
liquidation occurs (other than those made pursuant to this requirement 
(2) and requirement (3) of this paragraph (b)(2)(ii)(b)), by the end of 
such taxable year (or, if later, within 90 days after the date of such 
liquidation), and
    (3) If such partner has a deficit balance in his capital account 
following the liquidation of his interest in the partnership, as 
determined after taking into account all capital account adjustments for 
the partnership taxable year during which such liquidation occurs (other 
than those made pursuant to this requirement (3)), he is unconditionally 
obligated to restore the amount of such deficit balance to the 
partnership by the end of such taxable year (or, if later, within 90 
days after the date of such liquidation), which

[[Page 301]]

amount shall, upon liquidation of the partnership, be paid to creditors 
of the partnership or distributed to other partners in accordance with 
their positive capital account balances (in accordance with requirement 
(2) of this paragraph (b)(2)(ii)(b)).

For purposes of the preceding sentence, a partnership taxable year shall 
be determined without regard to section 706(c)(2)(A). Requirements (2) 
and (3) of this paragraph (b)(2)(ii)(b) are not violated if all or part 
of the partnership interest of one or more partners is purchased (other 
than in connection with the liquidation of the partnership) by the 
partnership or by one or more partners (or one or more persons related, 
within the meaning of section 267(b) (without modification by section 
267(e)(1)) or section 707(b)(1), to a partner) pursuant to an agreement 
negotiated at arm's length by persons who at the time such agreement is 
entered into have materially adverse interests and if a principal 
purpose of such purchase and sale is not to avoid the principles of the 
second sentence of paragraph (b)(2)(ii)(a) of this section. In addition, 
requirement (2) of this paragraph (b)(2)(ii)(b) is not violated if, upon 
the liquidation of the partnership, the capital accounts of the partners 
are increased or decreased pursuant to paragraph (b)(2)(iv)(f) of this 
section as of the date of such liquidation and the partnership makes 
liquidating distributions within the time set out in that requirement 
(2) in the ratios of the partners' positive capital accounts, except 
that it does not distribute reserves reasonably required to provide for 
liabilities (contingent or otherwise) of the partnership and installment 
obligations owed to the partnership, so long as such withheld amounts 
are distributed as soon as practicable and in the ratios of the 
partners' positive capital account balances. See examples 1(i) and (ii), 
(4)(i), (8)(i), and (16)(i) of paragraph (b)(5) of this section.
    (c) Obligation to restore deficit. If a partner is not expressly 
obligated to restore the deficit balance in his capital account, such 
partner nevertheless will be treated as obligated to restore the deficit 
balance in his capital account (in accordance with requirement (3) of 
paragraph (b)(2)(ii)(b) of this section) to the extent of--
    (1) The outstanding principal balance of any promissory note (of 
which such partner is the maker) contributed to the partnership by such 
partner (other than a promissory note that is readily tradable on an 
established securities market), and
    (2) The amount of any unconditional obligation of such partner 
(whether imposed by the partnership agreement or by State or local law) 
to make subsequent contributions to the partnership (other than pursuant 
to a promissory note of which such partner is the maker),

provided that such note or obligation is required to be satisfied at a 
time no later than the end of the partnership taxable year in which such 
partner's interest is liquidated (or, if later, within 90 days after the 
date of such liquidation). If a promissory note referred to in the 
previous sentence is negotiable, a partner will be considered required 
to satisfy such note within the time period specified in such sentence 
if the partnership agreement provides that, in lieu of actual 
satisfication, the partnership will retain such note and such partner 
will contribute to the partnership the excess, if any, of the 
outstanding principal balance of such note over its fair market value at 
the time of liquidation. See paragraph (b)(2)(iv)(d)(2) of this section. 
See examples (1)(ix) and (x) of paragraph (b)(5) of this section. A 
partner in no event will be considered obligated to restore the deficit 
balance in his capital account to the partnership (in accordance with 
requirement (3) of paragraph (b)(2)(ii)(b) of this section) to the 
extent such partner's obligation is not legally enforceable, or the 
facts and circumstances otherwise indicate a plan to avoid or circumvent 
such obligation. See paragraphs (b)(2)(ii)(f), (b)(2)(ii)(h), and 
(b)(4)(vi) of this section for other rules regarding such obligation. 
For purposes of this paragraph (b)(2), if a partner contributes a 
promissory note to the partnership during a partnership taxable year 
beginning after December 29, 1988 and the maker of such note is a person 
related to such partner (within the meaning of Sec. 1.752-

[[Page 302]]

1T(h), but without regard to subdivision (4) of that section), then such 
promissory note shall be treated as a promissory note of which such 
partner is the maker.
    (d) Alternate test for economic effect. If--
    (1) Requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this 
section are satisfied, and
    (2) The partner to whom an allocation is made is not obligated to 
restore the deficit balance in his capital account to the partnership 
(in accordance with requirement (3) of paragraph (b)(2)(ii)(b) of this 
section), or is obligated to restore only a limited dollar amount of 
such deficit balance, and
    (3) The partnership agreement contains a ``qualified income 
offset,''

such allocation will be considered to have economic effect under this 
paragraph (b)(2)(ii)(d) to the extent such allocation does not cause or 
increase a deficit balance in such partner's capital account (in excess 
of any limited dollar amount of such deficit balance that such partner 
is obligated to restore) as of the end of the partnership taxable year 
to which such allocation relates. In determining the extent to which the 
previous sentence is satisfied, such partner's capital account also 
shall be reduced for--
    (4) Adjustments that, as of the end of such year, reasonably are 
expected to be made to such partner's capital account under paragraph 
(b)(2)(iv)(k) of this section for depletion allowances with respect to 
oil and gas properties of the partnership, and
    (5) Allocations of loss and deduction that, as of the end of such 
year, reasonably are expected to be made to such partner pursuant to 
section 704(e)(2), section 706(d), and paragraph (b)(2)(ii) of Sec. 751-
1, and
    (6) Distributions that, as of the end of such year, reasonably are 
expected to be made to such partner to the extent they exceed offsetting 
increases to such partner's capital account that reasonably are expected 
to occur during (or prior to) the partnership taxable years in which 
such distributions reasonably are expected to be made (other than 
increases pursuant to a minimum gain chargeback under paragraph 
(b)(4)(iv)(e) of this section or under Sec. 1.704-2(f); however, 
increases to a partner's capital account pursuant to a minimum gain 
chargeback requirement are taken into account as an offset to 
distributions of nonrecourse liability proceeds that are reasonably 
expected to be made and that are allocable to an increase in partnership 
minimum gain).

For purposes of determining the amount of expected distributions and 
expected capital account increases described in (6) above, the rule set 
out in paragraph (b)(2)(iii)(c) of this section concerning the presumed 
value of partnership property shall apply. The partnership agreement 
contains a ``qualified income offset'' if, and only if, it provides that 
a partner who unexpectedly receives an adjustment, allocation, or 
distribution described in (4), (5), or (6) above, will be allocated 
items of income and gain (consisting of a pro rata portion of each item 
of partnership income, including gross income, and gain for such year) 
in an amount and manner sufficient to eliminate such deficit balance as 
quickly as possible. Allocations of items of income and gain made 
pursuant to the immediately preceding sentence shall be deemed to be 
made in accordance with the partners' interests in the partnership if 
requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this section are 
satisfied. See examples (1)(iii), (iv), (v), (vi), (viii), (ix), and 
(x), (15), and (16)(ii) of paragraph (b)(5) of this section.
    (e) Partial economic effect. If only a portion of an allocation made 
to a partner with respect to a partnership taxable year has economic 
effect, both the portion that has economic effect and the portion that 
is reallocated shall consist of a proportionate share of all items that 
made up the allocation to such partner for such year. See examples (15) 
(ii) and (iii) of paragraph (b)(5) of this section.
    (f) Reduction of obligation to restore. If requirements (1) and (2) 
of paragraph (b)(2)(ii)(b) of this section are satisfied, a partner's 
obligation to restore the deficit balance in his capital account (or any 
limited dollar amount thereof) to the partnership may be eliminated or 
reduced as of the end of a partnership taxable year without affecting 
the

[[Page 303]]

validity of prior allocations (see paragraph (b)(4)(vi) of this section) 
to the extent the deficit balance (if any) in such partner's capital 
account, after reduction for the items described in (4), (5), and (6) of 
paragraph (b)(2)(ii)(d) of this section, will not exceed the partner's 
remaining obligation (if any) to restore the deficit balance in his 
capital account. See example (1)(viii) of paragraph (b)(5) of this 
section.
    (g) Liquidation defined. For purposes of this paragraph, a 
liquidation of a partner's interest in the partnership occurs upon the 
earlier of (1) the date upon which there is a liquidation of the 
partnership, or (2) the date upon which there is a liquidation of the 
partner's interest in the partnership under paragraph (d) of Sec. 1.761-
1. For purposes of this paragraph, the liquidation of a partnership 
occurs upon the earlier of (3) the date upon which the partnership is 
terminated under section 708(b)(1), or (4) the date upon which the 
partnership ceases to be a going concern (even though it may continue in 
existence for the purpose of winding up its affairs, paying its debts, 
and distributing any remaining balance to its partners). Requirements 
(2) and (3) of paragraph (b)(2)(ii)(b) of this section will be 
considered unsatisfied if the liquidation of a partner's interest in the 
partnership is delayed after its primary business activities have been 
terminated (for example, by continuing to engage in a relatively minor 
amount of business activity, if such actions themselves do not cause the 
partnership to terminate pursuant to section 708(b)(1)) for a principal 
purpose of deferring any distribution pursuant to requirement (2) of 
paragraph (b)(2)(ii)(b) of this section or deferring any partner's 
obligations under requirement (3) of paragraph (b)(2)(ii)(b) of this 
section.
    (h) Partnership agreement defined. For purposes of this paragraph, 
the partnership agreement includes all agreements among the partners, or 
between one or more partners and the partnership, concerning affairs of 
the partnership and responsibilities of partners, whether oral or 
written, and whether or not embodied in a document referred to by the 
partners as the partnership agreement. Thus, in determining whether 
distributions are required in all cases to be made in accordance with 
the partners' positive capital account balances (requirement (2) of 
paragraph (b)(2)(ii)(b) of this section), and in determining the extent 
to which a partner is obligated to restore a deficit balance in his 
capital account (requirement (3) of paragraph (b)(2)(ii)(b) of this 
section), all arrangements among partners, or between one or more 
partners and the partnership relating to the partnership, direct and 
indirect, including puts, options, and other buy-sell agreements, and 
any other ``stop-loss'' arrangement, are considered to be part of the 
partnership agreement. (Thus, for example, if one partner who assumes a 
liability of the partnership is indemnified by another partner for a 
portion of such liability, the indemnifying partner (depending upon the 
particular facts) may be viewed as in effect having a partial deficit 
makeup obligation as a result of such indemnity agreement.) In addition, 
the partnership agreement includes provisions of Federal, State, or 
local law that govern the affairs of the partnership or are considered 
under such law to be a part of the partnership agreement (see the last 
sentence of paragraph (c) of Sec. 1.761-1). For purposes of this 
paragraph (b)(2)(ii)(h), an agreement with a partner or a partnership 
shall include an agreement with a person related, within the meaning of 
section 267(b) (without modification by section 267(e)(1)) or section 
707(b)(1), to such partner or partnership. For purposes of the preceding 
sentence, sections 267(b) and 707(b)(1) shall be applied for partnership 
taxable years beginning after December 29, 1988 by (1) substituting ``80 
percent or more'' for ``more than 50 percent'' each place it appears in 
such sections, (2) excluding brothers and sisters from the members of a 
person's family, and (3) disregarding Sec. 267(f)(1)(A).
    (i) Economic effect equivalence. Allocations made to a partner that 
do not otherwise have economic effect under this paragraph (b)(2)(ii) 
shall nevertheless be deemed to have economic effect, provided that as 
of the end of each partnership taxable year a liquidation of the 
partnership at the end of such year or at the end of any future year

[[Page 304]]

would produce the same economic results to the partners as would occur 
if requirements (1), (2), and (3) of paragraph (b)(2)(ii)(b) of this 
section had been satisfied, regardless of the economic performance of 
the partnership. See examples (4)(ii) and (iii) of paragraph (b)(5) of 
this section.
    (iii) Substantiality--(a) General rules. Except as otherwise 
provided in this paragraph (b)(2)(iii), the economic effect of an 
allocation (or allocations) is substantial if there is a reasonable 
possibility that the allocation (or allocations) will affect 
substantially the dollar amounts to be received by the partners from the 
partnership, independent of tax consequences. Notwithstanding the 
preceding sentence, the economic effect of an allocation (or 
allocations) is not substantial if, at the time the allocation becomes 
part of the partnership agreement, (1) the after-tax economic 
consequences of at least one partner may, in present value terms, be 
enhanced compared to such consequences if the allocation (or 
allocations) were not contained in the partnership agreement, and (2) 
there is a strong likelihood that the after-tax economic consequences of 
no partner will, in present value terms, be substantially diminished 
compared to such consequences if the allocation (or allocations) were 
not contained in the partnership agreement. In determining the after-tax 
economic benefit or detriment to a partner, tax consequences that result 
from the interaction of the allocation with such partner's tax 
attributes that are unrelated to the partnership will be taken into 
account. See examples 5 and 9 of paragraph (b)(5) of this section. The 
economic effect of an allocation is not substantial in the two 
situtations described in paragraphs (b)(2)(iii) (b) and (c) of this 
section. However, even if an allocation is not described therein, its 
economic effect may be insubstantial under the general rules stated in 
this paragraph (b)(2)(iii)(a). References in this paragraph (b)(2)(iii) 
to allocations include capital account adjustments made pursuant to 
paragraph (b)(2)(iv)(k) of this section.
    (b) Shifting tax consequences. The economic effect of an allocation 
(or allocations) in a partnership taxable year is not substantial if, at 
the time the allocation (or allocations) becomes part of the partnership 
agreement, there is a strong likelihood that--
    (1) The net increases and decreases that will be recorded in the 
partners' respective capital accounts for such taxable year will not 
differ substantially from the net increases and decreases that would be 
recorded in such partners' respective capital accounts for such year if 
the allocations were not contained in the partnership agreement, and
    (2) The total tax liability of the partners (for their respective 
taxable years in which the allocations will be taken into account) will 
be less than if the allocations were not contained in the partnership 
agreement (taking into account tax consequences that result from the 
interaction of the allocation (or allocations) with partner tax 
attributes that are unrelated to the partnership).

If, at the end of a partnership taxable year to which an allocation (or 
allocations) relates, the net increases and decreases that are recorded 
in the partners' respective capital accounts do not differ substantially 
from the net increases and decreases that would have been recorded in 
such partners' respective capital accounts had the allocation (or 
allocations) not been contained in the partnership agreement, and the 
total tax liability of the partners is (as described in (2) above) less 
than it would have been had the allocation (or allocations) not been 
contained in the partnership agreement, it will be presumed that, at the 
time the allocation (or allocations) became part of such partnership 
agreement, there was a strong likelihood that these results would occur. 
This presumption may be overcome by a showing of facts and circumstances 
that prove otherwise. See examples 6, 7(ii) and (iii), and (10)(ii) of 
paragraph (b)(5) of this section.
    (c) Transitory allocations. If a partnership agreement provides for 
the possibility that one or more allocations (the ``original 
allocation(s)'') will be largely offset by one or more other allocations 
(the ``offsetting allocation(s)''), and, at the time the allocations 
become part of the partnership agreement, there is a strong likelihood 
that--

[[Page 305]]

    (1) The net increases and decreases that will be recorded in the 
partners' respective capital accounts for the taxable years to which the 
allocations relate will not differ substantially from the net increases 
and decreases that would be recorded in such partners' respective 
capital accounts for such years if the original allocation(s) and 
offsetting allocation(s) were not contained in the partnership 
agreement, and
    (2) The total tax liability of the partners (for their respective 
taxable years in which the allocations will be taken into account) will 
be less than if the allocations were not contained in the partnership 
agreement (taking into account tax consequences that result from the 
interaction of the allocation (or allocations) with partner tax 
attributes that are unrelated to the partnership)

the economic effect of the original allocation(s) and offsetting 
allocation(s) will not be substantial. If, at the end of a partnership 
taxable year to which an offsetting allocation(s) relates, the net 
increases and decreases recorded in the partners' respective capital 
accounts do not differ substantially from the net increases and 
decreases that would have been recorded in such partners' respective 
capital accounts had the original allocation(s) and the offsetting 
allocation(s) not been contained in the partnership agreement, and the 
total tax liability of the partners is (as described in (2) above) less 
than it would have been had such allocations not been contained in the 
partnership agreement, it will be presumed that, at the time the 
allocations became part of the partnership agreement, there was a strong 
likelihood that these results would occur. This presumption may be 
overcome by a showing of facts and circumstances that prove otherwise. 
See examples (1)(xi), (2), (3), (7), (8)(ii), and (17) of paragraph 
(b)(5) of this section. Notwithstanding the foregoing, the original 
allocation(s) and the offsetting allocation(s) will not be insubstantial 
(under this paragraph (b)(2)(iii)(c)) and, for purposes of paragraph 
(b)(2)(iii)(a), it will be presumed that there is a reasonable 
possibility that the allocations will affect substantially the dollar 
amounts to be received by the partners from the partnership if, at the 
time the allocations become part of the partnership agreement, there is 
a strong likelihood that the offsetting allocation(s) will not, in large 
part, be made within five years after the original allocation(s) is made 
(determined on a first-in, first-out basis). See example 2 of paragraph 
(b)(5) of this section. For purposes of applying the provisions of this 
paragraph (b)(2)(iii) (and paragraphs (b)(2)(ii)(d)(6) and (b)(3)(iii) 
of this section), the adjusted tax basis of partnership property (or, if 
partnership property is properly reflected on the books of the 
partnership at a book value that differs from its adjusted tax basis, 
the book value of such property) will be presumed to be the fair market 
value of such property, and adjustments to the adjusted tax basis (or 
book value) of such property will be presumed to be matched by 
corresponding changes in such property's fair market value. Thus, there 
cannot be a strong likelihood that the economic effect of an allocation 
(or allocations) will be largely offset by an allocation (or 
allocations) of gain or loss from the disposition of partnership 
property. See examples 1 (vi) and (xi) of paragraph (b)(5) of this 
section.
    (iv) Maintenance of capital accounts--(a) In general. The economic 
effect test described in paragraph (b)(2)(ii) of this section requires 
an examination of the capital accounts of the partners of a partnership, 
as maintained under the partnership agreement. Except as otherwise 
provided in paragraph (b)(2)(ii)(i) of this section, an allocation of 
income, gain, loss, or deduction will not have economic effect under 
paragraph (b)(2)(ii) of this section, and will not be deemed to be in 
accordance with a partner's interest in the partnership under paragraph 
(b)(4) of this section, unless the capital accounts of the partners are 
determined and maintained throughout the full term of the partnership in 
accordance with the capital accounting rules of this paragraph 
(b)(2)(iv).
    (b) Basic rules. Except as otherwise provided in this paragraph 
(b)(2)(iv), the partners' capital accounts will be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) if, and only if,

[[Page 306]]

each partner's capital account is increased by (1) the amount of money 
contributed by him to the partnership, (2) the fair market value of 
property contributed by him to the partnership (net of liabilities 
secured by such contributed property that the partnership is considered 
to assume or take subject to under section 752), and (3) allocations to 
him of partnership income and gain (or items thereof), including income 
and gain exempt from tax and income and gain described in paragraph 
(b)(2)(iv)(g) of this section, but excluding income and gain described 
in paragraph (b)(4)(i) of this section; and is decreased by (4) the 
amount of money distributed to him by the partnership, (5) the fair 
market value of property distributed to him by the partnership (net of 
liabilities secured by such distributed property that such partner is 
considered to assume or take subject to under section 752), (6) 
allocations to him of expenditures of the partnership described in 
section 705 (a)(2)(B), and (7) allocations of partnership loss and 
deduction (or item thereof), including loss and deduction described in 
paragraph (b)(2)(iv)(g) of this section, but excluding items described 
in (6) above and loss or deduction described in paragraphs (b)(4)(i) or 
(b)(4)(iii) of this section; and is otherwise adjusted in accordance 
with the additional rules set forth in this paragraph (b)(2)(iv). For 
purposes of this paragraph, a partner who has more than one interest in 
a partnership shall have a single capital account that reflects all such 
interests, regardless of the class of interests owned by such partner 
(e.g., general or limited) and regardless of the time or manner in which 
such interests were acquired.
    (c) Treatment of liabilities. For purposes of this paragraph 
(b)(2)(iv), (1) money contributed by a partner to a partnership includes 
the amount of any partnership liabilities that are assumed by such 
partner (other than liabilities described in paragraph (b)(2)(iv)(b)(5) 
of this section that are assumed by a distributee partner) but does not 
include increases in such partner's share of partnership liabilities 
(see section 752(a)), and (2) money distributed to a partner by a 
partnership includes the amount of such partner's individual liabilities 
that are assumed by the partnership (other than liabilities described in 
paragraph (b)(2)(iv)(b)(2) of this section that are assumed by the 
partnership) but does not include decreases in such partner's share of 
partnership liabilities (see section 752(b)). For purposes of this 
paragraph (b)(2)(iv)(c), liabilities are considered assumed only to the 
extent the assuming party is thereby subjected to personal liability 
with respect to such obligation, the obligee is aware of the assumption 
and can directly enforce the assuming party's obligation, and, as 
between the assuming party and the party from whom the liability is 
assumed, the assuming party is ultimately liable.
    (d) Contributed property--(1) In general. The basic capital 
accounting rules contained in paragraph (b)(2)(iv)(b) of this section 
require that a partner's capital account be increased by the fair market 
value of property contributed to the partnership by such partner on the 
date of contribution. See examples 13 (i) and (v) of paragraph (b)(5) of 
this section. Consistent with section 752(c), section 7701(g) does not 
apply in determining such fair market value.
    (2) Contribution of promissory notes. Notwithstanding the general 
rule of paragraph (b)(2)(iv)(b)(2) of this section, except as provided 
in this paragraph (b)(2)(iv)(d)(2), if a promissory note is contributed 
to a partnership by a partner who is the maker of such note, such 
partner's capital account will be increased with respect to such note 
only when there is a taxable disposition of such note by the partnership 
or when the partner makes principal payments on such note. See example 
(1)(ix) of paragraph (b)(5) of this section. The first sentence of this 
paragraph (b)(2)(iv)(d)(2) shall not apply if the note referred to 
therein is readily tradable on an established securities market. See 
also paragraph (b)(2)(ii)(c) of this section. Furthermore, a partner 
whose interest is liquidated will be considered as satisfying his 
obligation to restore the deficit balance in his capital account to the 
extent of (i) the fair market value, at the time of contribution, of any 
negotiable promissory note (of which such partner is the maker) that 
such partner contributes

[[Page 307]]

to the partnership on or after the date his interest is liquidated and 
within the time specified in paragraph (b)(2)(ii)(b)(3) of this section, 
and (ii) the fair market value, at the time of liquidation, of the 
unsatisfied portion of any negotiable promissory note (of which such 
partner is the maker) that such partner previously contributed to the 
partnership. For purposes of the preceding sentence, the fair market 
value of a note will be no less than the outstanding principal balance 
of such note, provided that such note bears interest at a rate no less 
than the applicable federal rate at the time of valuation.
    (3) Section 704(c) considerations. Section 704(c) and Sec. 1.704-3 
govern the determination of the partners' distributive shares of income, 
gain, loss, and deduction, as computed for tax purposes, with respect to 
property contributed to a partnership (see paragraph (b)(1)(vi) of this 
section). In cases where section 704(c) and Sec. 1.704-3 apply to 
partnership property, the capital accounts of the partners will not be 
considered to be determined and maintained in accordance with the rules 
of this paragraph (b)(2)(iv) unless the partnership agreement requires 
that the partners' capital accounts be adjusted in accordance with 
paragraph (b)(2)(iv)(g) of this section for allocations to them of 
income, gain, loss, and deduction (including depreciation, depletion, 
amortization, or other cost recovery) as computed for book purposes, 
with respect to the property. See, however, Sec. 1.704-3(d)(2) for a 
special rule in determining the amount of book items if the partnership 
chooses the remedial allocation method. See also Example (13) (i) of 
paragraph (b)(5) of this section. Capital accounts are not adjusted to 
reflect allocations under section 704(c) and Sec. 1.704-3 (e.g., tax 
allocations of precontribution gain or loss).
    (e) Distributed property--(1) In general. The basic capital 
accounting rules contained in paragraph (b)(2)(iv) (b) of this section 
require that a partner's capital account be decreased by the fair market 
value of property distributed by the partnership (without regard to 
section 7701(g)) to such partner (whether in connection with a 
liquidation or otherwise). To satisfy this requirement, the capital 
accounts of the partners first must be adjusted to reflect the manner in 
which the unrealized income, gain, loss, and deduction inherent in such 
property (that has not been reflected in the capital accounts 
previously) would be allocated among the partners if there were a 
taxable disposition of such property for the fair market value of such 
property (taking section 7701(g) into account) on the date of 
distribution. See example (14)(v) of paragraph (b)(5) of this section.
    (2) Distribution of promissory notes. Notwithstanding the general 
rule of paragraph (b)(2)(iv)(b)(5), except as provided in this paragraph 
(b)(2)(iv)(e)(2), if a promissory note is distributed to a partner by a 
partnership that is the maker of such note, such partner's capital 
account will be decreased with respect to such note only when there is a 
taxable disposition of such note by the partner or when the partnership 
makes principal payments on the note. The previous sentence shall not 
apply if a note distributed to a partner by a partnership who is the 
maker of such note is readily tradable on an established securities 
market. Furthermore, the capital account of a partner whose interest in 
a partnership is liquidated will be reduced to the extent of (i) the 
fair market value, at the time of distribution, of any negotiable 
promissory note (of which such partnership is the maker) that such 
partnership distributes to the partner on or after the date such 
partner's interest is liquidated and within the time specified in 
paragraph (b)(2)(ii)(b)(2) of this section, and (ii) the fair market 
value, at the time of liquidation, of the unsatisfied portion of any 
negotiable promissory note (of which such partnership is the maker) that 
such partnership previously distributed to the partner. For purposes of 
the preceding sentence, the fair market value of a note will be no less 
than the outstanding principal balance of such note, provided that such 
note bears interest at a rate no less than the applicable Federal rate 
at time of valuation.

[[Page 308]]

    (f) Revaluations of property. A partnership agreement may, upon the 
occurrence of certain events, increase or decrease the capital accounts 
of the partners to reflect a revaluation of partnership property 
(including intangible assets such as goodwill) on the partnership's 
books. Capital accounts so adjusted will not be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) unless--
    (1) The adjustments are based on the fair market value of 
partnership property (taking section 7701(g) into account) on the date 
of adjustment, and
    (2) The adjustments reflect the manner in which the unrealized 
income, gain, loss, or deduction inherent in such property (that has not 
been reflected in the capital accounts previously) would be allocated 
among the partners if there were a taxable disposition of such property 
for such fair market value on that date, and
    (3) The partnership agreement requires that the partners' capital 
accounts be adjusted in accordance with paragraph (b)(2)(iv)(g) of this 
section for allocations to them of depreciation, depletion, 
amortization, and gain or loss, as computed for book purposes, with 
respect to such property, and
    (4) The partnership agreement requires that the partners' 
distributive shares of depreciation, depletion, amortization, and gain 
or loss, as computed for tax purposes, with respect to such property be 
determined so as to take account of the variation between the adjusted 
tax basis and book value of such property in the same manner as under 
section 704(c) (see paragraph (b)(4)(i) of this section), and
    (5) The adjustments are made principally for a substantial non-tax 
business purpose--
    (i) In connection with a contribution of money or other property 
(other than a de minimis amount) to the partnership by a new or existing 
partner as consideration for an interest in the partnership, or
    (ii) In connection with the liquidation of the partnership or a 
distribution of money or other property (other than a de minimis amount) 
by the partnership to a retiring or continuing partner as consideration 
for an interest in the partnership, or
    (iii) Under generally accepted industry accounting practices, 
provided substantially all of the partnership's property (excluding 
money) consists of stock, securities, commodities, options, warrants, 
futures, or similar instruments that are readily tradable on an 
established securities market.

See examples 14 and 18 of paragraph (b)(5) of this section. If the 
capital accounts of the partners are not adjusted to reflect the fair 
market value of partnership property when an interest in the partnership 
is acquired from or relinquished to the partnership, paragraphs 
(b)(1)(iii) and (b)(1)(iv) of this section should be consulted regarding 
the potential tax consequences that may arise if the principles of 
section 704(c) are not applied to determine the partners' distributive 
shares of depreciation, depletion, amortization, and gain or loss as 
computed for tax purposes, with respect to such property.
    (g) Adjustments to reflect book value--(1) In general. Under 
paragraphs (b)(2)(iv)(d) and (b)(2)(iv)(f) of this section, property may 
be properly reflected on the books of the partnership at a book value 
that differs from the adjusted tax basis of such property. In these 
circumstances, paragraphs (b)(2)(iv)(d)(3) and (b)(2)(iv)(f)(3) of this 
section provide that the capital accounts of the partners will not be 
considered to be determined and maintained in accordance with the rules 
of this paragraph (b)(2)(iv) unless the partnership agreement requires 
the partners' capital accounts to be adjusted in accordance with this 
paragraph (b)(2)(iv)(g) for allocations to them of depreciation, 
depletion, amortization, and gain or loss, as computed for book 
purposes, with respect to such property. In determining whether the 
economic effect of an allocation of book items is substantial, 
consideration will be given to the effect of such allocation on the 
determination of the partners' distributive shares of corresponding tax 
items under section 704(c) and paragraph (b)(4)(i) of this section. See 
example 17 of paragraph (b)(5) of this section. If an allocation of book 
items under the partnership agreement does not have substantial

[[Page 309]]

economic effect (as determined under paragraphs (b)(2)(ii) and 
(b)(2)(iii) of this section), or is not otherwise respected under this 
paragraph, such items will be reallocated in accordance with the 
partners' interests in the partnership, and such reallocation will be 
the basis upon which the partners' distributive shares of the 
corresponding tax items are determined under section 704(c) and 
paragraph (b)(4)(i) of this section. See examples 13, 14, and 18 of 
paragraph (b)(5) of this section.
    (2) Payables and receivables. References in this paragraph 
(b)(2)(iv) and paragraph (b)(4)(i) of this section to book and tax 
depreciation, depletion, amortization, and gain or loss with respect to 
property that has an adjusted tax basis that differs from book value 
include, under analogous rules and principles, the unrealized income or 
deduction with respect to accounts receivable, accounts payable, and 
other accrued but unpaid items.
    (3) Determining amount of book items. The partners' capital accounts 
will not be considered adjusted in accordance with this paragraph 
(b)(2)(iv)(g) unless the amount of book depreciation, depletion, or 
amortization for a period with respect to an item of partnership 
property is the amount that bears the same relationship to the book 
value of such property as the depreciation (or cost recovery deduction), 
depletion, or amortization computed for tax purposes with respect to 
such property for such period bears to the adjusted tax basis of such 
property. If such property has a zero adjusted tax basis, the book 
depreciation, depletion, or amortization may be determined under any 
reasonable method selected by the partnership.
    (h) Determinations of fair market value. For purposes of this 
paragraph (b)(2)(iv), the fair market value assigned to property 
contributed to a partnership, property distributed by a partnership, or 
property otherwise revalued by a partnership, will be regarded as 
correct, provided that (1) such value is reasonably agreed to among the 
partners in arm's-length negotiations, and (2) the partners have 
sufficiently adverse interests. If, however, these conditions are not 
satisfied and the value assigned to such property is overstated or 
understated (by more than an insignificant amount), the capital accounts 
of the partners will not be considered to be determined and maintained 
in accordance with the rules of this paragraph (b)(2)(iv). Valuation of 
property contributed to the partnership, distributed by the partnership, 
or otherwise revalued by the partnership shall be on a property-by-
property basis, except to the extent the regulations under section 
704(c) permit otherwise.
    (i) Section 705(a)(2)(B) expenditures--(1) In general. The basic 
capital accounting rules contained in paragraph (b)(2)(iv)(b) of this 
section require that a partner's capital account be decreased by 
allocations made to such partner of expenditures described in section 
705(a)(2)(B). See example 11 of paragraph (b)(5) of this section. If an 
allocation of these expenditures under the partnership agreement does 
not have substantial economic effect (as determined under paragraphs 
(b)(2)(ii) and (b)(2)(iii) of this section), or is not otherwise 
respected under this paragraph, such expenditures will be reallocated in 
accordance with the partners' interest in the partnership.
    (2) Expenses described in section 709. Except for amounts with 
respect to which an election is properly made under section 709(b), 
amounts paid or incurred to organize a partnership or to promote the 
sale of (or to sell) an interest in such a partnership shall, solely for 
purposes of this paragraph, be treated as section 705(a)(2)(B) 
expenditures, and upon liquidation of the partnership no further capital 
account adjustments will be made in respect thereof.
    (3) Disallowed losses. If a deduction for a loss incurred in 
connection with the sale or exchange of partnership property is 
disallowed to the partnership under section 267(a)(1) or section 707(b), 
that deduction shall, solely for purposes of this paragraph, be treated 
as a section 705(a)(2)(B) expenditure.
    (j) Basis adjustments to section 38 property. The capital accounts 
of the partners will not be considered to be determined and maintained 
in accordance with the rules of this paragraph (b)(2)(iv) unless such 
capital accounts are adjusted by the partners' shares of

[[Page 310]]

any upward or downward basis adjustments allocated to them under this 
paragraph (b)(2)(iv)(j). When there is a reduction in the adjusted tax 
basis of partnership section 38 property under section 48(q)(1) or 
section 48(q)(3), section 48(q)(6) provides for an equivalent downward 
adjustment to the aggregate basis of partnership interests (and no 
additional adjustment is made under section 705(a)(2)(B)). These 
downward basis adjustments shall be shared among the partners in the 
same proportion as the adjusted tax basis or cost of (or the qualified 
investment in) such section 38 property is allocated among the partners 
under paragraph (f) of Sec. 1.46-3 (or paragraph (a)(4)(iv) of 
Sec. 1.48-8). Conversely, when there is an increase in the adjusted tax 
basis of partnership section 38 property under section 48(q)(2), section 
48(q)(6) provides for an equivalent upward adjustment to the aggregate 
basis of partnership interests. These upward adjustments shall be 
allocated among the partners in the same proportion as the investment 
tax credit from such property is recaptured by the partners under 
Sec. 1.47-6.
    (k) Depletion of oil and gas properties--(1) In general. The capital 
accounts of the partners will not be considered to be determined and 
maintained in accordance with the rules of this paragraph (b)(2)(iv) 
unless such capital accounts are adjusted for depletion and gain or loss 
with respect to the oil or gas properties of the partnership in 
accordance with this paragraph (b)(2)(iv)(k).
    (2) Simulated depletion. Except as provided in paragraph 
(b)(2)(iv)(k) (3) of this section, a partnership shall, solely for 
purposes of maintaining capital accounts under this paragraph, compute 
simulated depletion allowances with respect to its oil and gas 
properties at the partnership level. These allowances shall be computed 
on each depletable oil or gas property of the partnership by using 
either the cost depletion method or the percentage depletion method 
(computed in accordance with section 613 at the rates specified in 
section 613A(c)(5) without regard to the limitations of section 613A, 
which theoretically could apply to any partner) for each partnership 
taxable year that the property is owned by the partnership and subject 
to depletion. The choice between the simulated cost depletion method and 
the simulated percentage depletion method shall be made on a property-
by-property basis in the first partnership taxable year beginning after 
April 30, 1986, for which it is relevent for the property, and shall be 
binding for all partnership taxable years during which the oil or gas 
property is held by the partnership. The partnership shall make downward 
adjustments to the capital accounts of the partners for the simulated 
depletion allowance with respect to each oil or gas property of the 
partnership, in the same proportion as such partners (or their 
precedecessors in interest) were properly allocated the adjusted tax 
basis of each such property. The aggregate capital account adjustments 
for simulated percentage depletion allowances with respect to an oil or 
gas property of the partnership shall not exceed the aggregate adjusted 
tax basis allocated to the partners with respect to such property. Upon 
the taxable disposition of an oil or gas property by a partnership, such 
partnership's simulated gain or loss shall be determined by subtracting 
its simulated adjusted basis in such property from the amount realized 
upon such disposition. (The partnership's simulated adjusted basis in an 
oil or gas property is determined in the same manner as adjusted tax 
basis except that simulated depletion allowances are taken into account 
instead of actual depletion allowances.) The capital accounts of the 
partners shall be adjusted upward by the amount of any simulated gain in 
proportion to such partners' allocable shares of the portion of the 
total amount realized from the disposition of such property that exceeds 
the partnership's simulated adjusted basis in such property. The capital 
accounts of such partners shall be adjusted downward by the amount of 
any simulated loss in proportion to such partners' allocable shares of 
the total amount realized from the disposition of such property that 
represents recovery of the partnership's simulated adjusted basis in 
such property. See section 613A(c)(7)(D) and the regulations thereunder 
and paragraph (b)(4)(v) of this section. See

[[Page 311]]

example (19)(iv) of paragraph (b)(5) of this section.
    (3) Actual depletion. Pursuant to section 613A(c)(7)(D) and the 
regulations thereunder, the depletion allowance under section 611 with 
respect to the oil and gas properties of a partnership is computed 
separately by the partners. Accordingly, in lieu of adjusting the 
partner's capital accounts as provided in paragraph (b)(2)(iv)(k)(2) of 
this section, the partnership may make downward adjustments to the 
capital account of each partner equal to such partner's depletion 
allowance with respect to each oil or gas property of the partnership 
(for the partner's taxable year that ends with or within the 
partnership's taxable year). The aggregate adjustments to the capital 
account of a partner for depletion allowances with respect to an oil or 
gas property of the partnership shall not exceed the adjusted tax basis 
allocated to such partner with respect to such property. Upon the 
taxable disposition of an oil or gas property by a partnership, the 
capital account of each partner shall be adjusted upward by the amount 
of any excess of such partner's allocable share of the total amount 
realized from the disposition of such property over such partner's 
remaining adjusted tax basis in such property. If there is no such 
excess, the capital account of such partner shall be adjusted downward 
by the amount of any excess of such partner's remaining adjusted tax 
basis in such property over such partner's allocable share of the total 
amount realized from the disposition thereof. See section 
613A(c)(7)(4)(D) and the regulations thereunder and paragraph (b)(4)(v) 
of this section.
    (4) Effect of book values. If an oil or gas property of the 
partnership is, under paragraphs (b)(2)(iv(d) or (b)(2)(iv)(f) of this 
section, properly reflected on the books of the partnership at a book 
value that differs from the adjusted tax basis of such property, the 
rules contained in this paragraph (b)(2)(iv)(k) and paragraph (b)(4)(v) 
of this section shall be applied with reference to such book value. A 
revaluation of a partnership oil or gas property under paragraph 
(b)(2)(iv)(f) of this section may give rise to a reallocation of the 
adjusted tax basis of such property, or a change in the partners' 
relative shares of simulated depletion from such property, only to the 
extent permitted by section 613A(c)(7)(D) and the regulations 
thereunder.
    (l) Transfers of partnership interests. The capital accounts of the 
partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless, upon the 
transfer of all or a part of an interest in the partnership, the capital 
account of the transferor that is attributable to the transferred 
interest carries over to the transferee partner. (See paragraph 
(b)(2)(iv)(m) of this section for rules concerning the effect of a 
section 754 election on the capital accounts of the partners.) However, 
if the transfer of an interest in a partnership causes a termination of 
the partnership under section 708(b)(1)(B), the capital account that 
carriers over to the transferee partner will be adjusted in accordance 
with paragraph (b)(2)(iv)(e) of this section in connection with the 
constructive liquidation of the partnership under paragraph (b)(1)(iv) 
of Sec. 1.708-1. Moreover, the constructive reformation of such 
partnership will, for purposes of this paragraph, be treated as the 
formation of a new partnership, and the capital accounts of the partners 
of such new partnership will be determined and maintained accordingly. 
See example 13 of paragraph (b)(5) of this section.
    (m) Section 754 elections--(1) In general. The capital accounts of 
the partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless, upon 
adjustment to the adjusted tax basis of partnership property under 
section 732, 734, or 743, the capital accounts of the partners are 
adjusted as provided in this paragraph (b)(2)(iv)(m).
    (2) Section 743 adjustments. In the case of a transfer of all or a 
part of an interest in a partnership that has a section 754 election in 
effect for the partnership taxable year in which such transfer occurs, 
adjustments to the adjusted tax basis of partnership property under 
section 743 shall not be reflected in the capital account of the 
transferee partner or on the books of the partnership, and subsequent 
capital account adjustments for distributions (see paragraph

[[Page 312]]

(b)(2)(iv)(e)(1) of this section) and for depreciation, depletion, 
amortization, and gain or loss with respect to such property will 
disregard the effect of such basis adjustment. The preceding sentence 
shall not apply to the extent such basis adjustment is allocated to the 
common basis of partnership property under paragraph (b)(1) of 
Sec. 1.734-2; in these cases, such basis adjustment shall, except as 
provided in paragraph (b)(2)(iv)(m)(5) of this section, give rise to 
adjustments to the capital accounts of the partners in accordance with 
their interests in the partnership under paragraph (b)(3) of this 
section. See examples 13 (iii) and (iv) of paragraph (b)(5) of this 
section.
    (3) Section 732 adjustments. In the case of a transfer of all or a 
part of an interest in a partnership that does not have a section 754 
election in effect for the partnership taxable year in which such 
transfer occurs, adjustments to the adjusted tax basis of partnership 
property under section 732(d) will be treated in the capital accounts of 
the partners in the same manner as section 743 basis adjustments are 
treated under paragraph (b)(2)(iv)(m)(2) of this section.
    (4) Section 734 adjustments. Except as provided in paragraph 
(b)(2)(iv)(m)(5) of this section, in the case of a distribution of 
property in liquidation of a partner's interest in the partnership by a 
partnership that has a section 754 election in effect for the 
partnership taxable year in which the distribution occurs, the partner 
who receives the distribution that gives rise to the adjustment to the 
adjusted tax basis of partnership property under section 734 shall have 
a corresponding adjustment made to his capital account. If such 
distribution is made other than in liquidation of a partner's interest 
in the partnership, however, except as provided in paragraph 
(b)(2)(iv)(m)(5) of this section, the capital accounts of the partners 
shall be adjusted by the amount of the adjustment to the adjusted tax 
basis of partnership property under section 734, and such capital 
account adjustment shall be shared among the partners in the manner in 
which the unrealized income and gain that is displaced by such 
adjustment would have been shared if the property whose basis is 
adjusted were sold immediately prior to such adjustment for its 
recomputed adjusted tax basis.
    (5) Limitations on adjustments. Adjustments may be made to the 
capital account of a partner (or his successor in interest) in respect 
of basis adjustments to partnership property under sections 732, 734, 
and 743 only to the extent that such basis adjustments (i) are permitted 
to be made to one or more items of partnership property under section 
755, and (ii) result in an increase or a decrease in the amount at which 
such property is carried on the partnership's balance sheet, as computed 
for book purposes. For example, if the book value of partnership 
property exceeds the adjusted tax basis of such property, a basis 
adjustment to such property may be reflected in a partner's capital 
account only to the extent such adjustment exceeds the difference 
between the book value of such property and the adjusted tax basis of 
such property prior to such adjustment.
    (n) Partnership level characterization. Except as otherwise provided 
in paragraph (b)(2)(iv)(k) of this section, the capital accounts of the 
partners will not be considered to be determined and maintained in 
accordance with the rules of this paragraph (b)(2)(iv) unless 
adjustments to such capital accounts in respect of partnership income, 
gain, loss, deduction, and section 705(a)(2)(B) expenditures (or item 
thereof) are made with reference to the Federal tax treatment of such 
items (and in the case of book items, with reference to the Federal tax 
treatment of the corresponding tax items) at the partnership level, 
without regard to any requisite or elective tax treatment of such items 
at the partner level (for example, under section 58(i)). However, a 
partnership that incurs mining exploration expenditures will determine 
the Federal tax treatment of income, gain, loss, and deduction with 
respect to the property to which such expenditures relate at the 
partnership level only after first taking into account the elections 
made by its partners under section 617 and section 703(b)(4).
    (o) Guaranteed payments. Guaranteed payments to a partner under 
section 707(c) cause the capital account of the recipient partner to be 
adjusted only to

[[Page 313]]

the extent of such partner's distributive share of any partnership 
deduction, loss, or other downward capital account adjustment resulting 
from such payment.
    (p) Minor discrepancies. Discrepancies between the balances in the 
respective capital accounts of the partners and the balances that would 
be in such respective capital accounts if they had been determined and 
maintained in accordance with this paragraph (b)(2)(iv) will not 
adversely affect the validity of an allocation, provided that such 
discrepancies are minor and are attributable to good faith error by the 
partnership.
    (q) Adjustments where guidance is lacking. If the rules of this 
paragraph (b)(2)(iv) fail to provide guidance on how adjustments to the 
capital accounts of the partners should be made to reflect particular 
adjustments to partnership capital on the books of the partnership, such 
capital accounts will not be considered to be determined and maintained 
in accordance with those rules unless such capital account adjustments 
are made in a manner that (1) maintains equality between the aggregate 
governing capital accounts of the partners and the amount of partnership 
capital reflected on the partnership's balance sheet, as computed for 
book purposes, (2) is consistent with the underlying economic 
arrangement of the partners, and (3) is based, wherever practicable, on 
Federal tax accounting principles.
    (r) Restatement of capital accounts. With respect to partnerships 
that began operating in a taxable year beginning before May 1, 1986, the 
capital accounts of the partners of which have not been determined and 
maintained in accordance with the rules of this paragraph (b)(2)(iv) 
since inception, such capital accounts shall not be considered to be 
determined and maintained in accordance with the rules of this paragraph 
(b)(2)(iv) for taxable years beginning after April 30, 1986, unless 
either--
    (1) Such capital accounts are adjusted, effective for the first 
partnership taxable year beginning after April 30, 1986, to reflect the 
fair market value of partnership property as of the first day of such 
taxable year, and in connection with such adjustment, the rules 
contained in paragraph (b)(2)(iv)(f) (2), (3), and (4) of this section 
are satisfied, or
    (2) The differences between the balance in each partner's capital 
account and the balance that would be in such partner's capital account 
if capital accounts had been determined and maintained in accordance 
with this paragraph (b)(2)(iv) throughout the full term of the 
partnership are not significant (for example, such differences are 
solely attributable to a failure to provide for treatment of section 709 
expenses in accordance with the rules of paragraph (b)(2)(iv)(i)(2) of 
this section or to a failure to follow the rules in paragraph 
(b)(2)(iv)(m) of this section), and capital accounts are adjusted to 
bring them into conformity with the rules of this paragraph (b)(2)(iv) 
no later than the end of the first partnership taxable year beginning 
after April 30, 1986.

With respect to a partnership that began operating in a taxable year 
beginning before May 1, 1986, modifications to the partnership agreement 
adopted on or before November 1, 1988, to make the capital account 
adjustments required to comply with this paragraph, and otherwise to 
satisfy the requirements of this paragraph, will be treated as if such 
modifications were included in the partnership agreement before the end 
of the first partnership taxable year beginning after April 30, 1986. 
However, compliance with the previous sentences will have no bearing on 
the validity of allocations that relate to partnership taxable years 
beginning before May 1, 1986.
    (3) Partner's interest in the partnership--(i) In general. 
References in section 704(b) and this paragraph to a partner's interest 
in the partnership, or to the partners' interests in the partnership, 
signify the manner in which the partners have agreed to share the 
economic benefit or burden (if any) corresponding to the income, gain, 
loss, deduction, or credit (or item thereof) that is allocated. Except 
with respect to partnership items that cannot have economic effect (such 
as nonrecourse deductions of the partnership), this sharing arrangement 
may or

[[Page 314]]

may not correspond to the overall economic arrangement of the partners. 
Thus, a partner who has a 50 percent overall interest in the partnership 
may have a 90 percent interest in a particular item of income or 
deduction. (For example, in the case of an unexpected downward 
adjustment to the capital account of a partner who does not have a 
deficit make-up obligation that causes such partner to have a negative 
capital account, it may be necessary to allocate a disproporationate 
amount of gross income of the partnership to such partner for such year 
so as to bring that partner's capital account back up to zero.) The 
determination of a partner's interest in a partnership shall be made by 
taking into account all facts and circumstances relating to the economic 
arrangement of the partners. All partners' interests in the partnership 
are presumed to be equal (determined on a per capita basis). However, 
this presumption may be rebutted by the taxpayer or the Internal Revenue 
Service by establishing facts and circumstances that show that the 
partners' interests in the partnership are otherwise.
    (ii) Factors considered. In determining a partner's interest in the 
partnership, the following factors are among those that will be 
considered:
    (a) The partners' relative contributions to the partnership,
    (b) The interests of the partners in economic profits and losses (if 
different than that in taxable income or loss),
    (c) The interests of the partners in cash flow and other non-
liquidating distributions, and
    (d) The rights of the partners to distributions of capital upon 
liquidation.

The provisions of this subparagraph (b)(3) are illustrated by examples 
(1)(i) and (ii), (4)(i), (5)(i) and (ii), (6), (7), (8), (10)(ii), 
(16)(i), and (19)(iii) of paragraph (b)(5) of this section. See 
paragraph (b)(4)(i) of this section concerning rules for determining the 
partners' interests in the partnership with respect to certain tax 
items.
    (iii) Certain determinations. If--
    (a) Requirements (1) and (2) of paragraph (b)(2)(ii)(b) of this 
section are satisfied, and
    (b) All or a portion of an allocation of income, gain, loss, or 
deduction made to a partner for a partnership taxable year does not have 
economic effect under paragraph (b)(2)(ii) of this section.

the partners' interests in the partnership with respect to the portion 
of the allocation that lacks economic effect will be determined by 
comparing the manner in which distributions (and contributions) would be 
made if all partnership property were sold at book value and the 
partnership were liquidated immediately following the end of the taxable 
year to which the allocation relates with the manner in which 
distributions (and contributions) would be made if all partnership 
property were sold at book value and the partnership were liquidated 
immediately following the end of the prior taxable year, and adjusting 
the result for the items described in (4), (5), and (6) of paragraph 
(b)(2)(ii)(d) of this section. A determination made under this paragraph 
(b)(3)(iii) will have no force if the economic effect of valid 
allocations made in the same manner is insubstantial under paragraph 
(b)(2)(iii) of this section. See examples 1 (iv), (v), and (vi), and 15 
(ii) and (iii) of paragraph (b)(5) of this section.
    (4) Special rules--(i) Allocations to reflect revaluations. If 
partnership property is, under paragraphs (b)(2)(iv)(d) or (b)(2)(iv)(f) 
of this section, properly reflected in the capital accounts of the 
partners and on the books of the partnership at a book value that 
differs from the adjusted tax basis of such property, then depreciation, 
depletion, amortization, and gain or loss, as computed for book 
purposes, with respect to such property will be greater or less than the 
depreciation, depletion, amortization, and gain or loss, as computed for 
tax purposes, with respect to such property. In these cases the capital 
accounts of the partners are required to be adjusted solely for 
allocations of the book items to such partners (see paragraph 
(b)(2)(iv)(g) of this section), and the partners' shares of the 
corresponding tax items are not independently reflected by further 
adjustments to the partners' capital accounts. Thus, separate 
allocations of these tax items cannot have economic effect under 
paragraph (b)(2)(ii)(b)(1) of this section, and the partners' 
distributive shares of

[[Page 315]]

such tax items must (unless governed by section 704(c)) be determined in 
accordance with the partners' interests in the partnership. These tax 
items must be shared among the partners in a manner that takes account 
of the variation between the adjusted tax basis of such property and its 
book value in the same manner as variations between the adjusted tax 
basis and fair market value of property contributed to the partnership 
are taken into account in determining the partners' shares of tax items 
under section 704(c). See examples 14 and 18 of paragraph (b)(5) of this 
section.
    (ii) Credits. Allocations of tax credits and tax credit recapture 
are not reflected by adjustments to the partners' capital accounts 
(except to the extent that adjustments to the adjusted tax basis of 
partnership section 38 property in respect of tax credits and tax credit 
recapture give rise to capital account adjustments under paragraph 
(b)(2)(iv)(j) of this section). Thus, such allocations cannot have 
economic effect under paragraph (b)(2)(ii)(b)(1) of this section, and 
the tax credits and tax credit recapture must be allocated in accordance 
with the partners' interests in the partnership as of the time the tax 
credit or credit recapture arises. With respect to the investment tax 
credit provided by section 38, allocations of cost or qualified 
investment made in accordance with paragraph (f) of Sec. 1.46-3 and 
paragraph (a)(4)(iv) of Sec. 1.48-8 shall be deemed to be made in 
accordance with the partners' interests in the partnership. With respect 
to other tax credits, if a partnership expenditure (whether or not 
deductible) that gives rise to a tax credit in a partnership taxable 
year also gives rise to valid allocations of partnership loss or 
deduction (or other downward capital account adjustments) for such year, 
then the partners' interests in the partnership with respect to such 
credit (or the cost giving rise thereto) shall be in the same proportion 
as such partners' respective distributive shares of such loss or 
deduction (and adjustments). See example 11 of paragraph (b)(5) of this 
section. Identical principles shall apply in determining the partners' 
interests in the partnership with respect to tax credits that arise from 
receipts of the partnership (whether or not taxable).
    (iii) Excess percentage depletion. To the extent the percentage 
depletion in respect of an item of depletable property of the 
partnership exceeds the adjusted tax basis of such property, allocations 
of such excess percentage depletion are not reflected by adjustments to 
the partners' capital accounts. Thus, such allocations cannot have 
economic effect under paragraph (b)(2)(ii)(b)(1) of this section, and 
such excess percentage depletion must be allocated in accordance with 
the partners' interests in the partnership. The partners' interests in 
the partnership for a partnership taxable year with respect to such 
excess percentage depletion shall be in the same proportion as such 
partners' respective distributive shares of gross income from the 
depletable property (as determined under section 613(c)) for such year. 
See example 12 of paragraph (b)(5) of this section. See paragraphs 
(b)(2)(iv)(k) and (b)(4)(v) of this section for special rules concerning 
oil and gas properties of the partnership.
    (iv) Allocations attributable to nonrecourse liabilities. The rules 
for allocations attributable to nonrecourse liabilities are contained in 
Sec. 1.704-2.
    (v) Allocations under section 613A(c)(7)(D). Allocations of the 
adjusted tax basis of a partnership oil or gas property are controlled 
by section 613A(c)(7)(D) and the regulations thereunder. However, if the 
partnership agreement provides for an allocation of the adjusted tax 
basis of an oil or gas property among the partners, and such allocation 
is not otherwise governed under section 704(c) (or related principles 
under paragraph (b)(4)(i) of this section), that allocation will be 
recognized as being in accordance with the partners' interests in 
partnership capital under section 613A(c)(7)(D), provided (a) such 
allocation does not give rise to capital account adjustments under 
paragraph (b)(2)(iv)(k) of this section, the economic effect of which is 
insubstantial (as determined under paragraph (b)(2)(iii) of this 
section), and (b) all other material allocations and capital account 
adjustments under

[[Page 316]]

the partnership agreement are recognized under this paragraph (b). 
Otherwise, such adjusted tax basis must be allocated among the partners 
pursuant to section 613A(c)(7)(D) in accordance with the partners' 
actual interests in partnership capital or income. For purposes of 
section 613A(c)(7)(D) the partners' allocable shares of the amount 
realized upon the partnership's taxable disposition of an oil or gas 
property will, except to the extent governed by section 704(c) (or 
related principles under paragraph (b)(4)(i) of this section), be 
determined under this paragraph (b)(4)(v). If, pursuant to paragraph 
(b)(2)(iv)(k)(2) of this section, the partners' capital accounts are 
adjusted to reflect the simulated depletion of an oil or gas property of 
the partnership, the portion of the total amount realized by the 
partnership upon the taxable disposition of such property that 
represents recovery of its simulated adjusted tax basis therein will be 
allocated to the partners in the same proportion as the aggregate 
adjusted tax basis of such property was allocated to such partners (or 
their predecessors in interest). If, pursuant to paragraph 
(b)(2)(iv)(k)(3) of this section, the partners' capital accounts are 
adjusted to reflect the actual depletion of an oil or gas property of 
the partnership, the portion of the total amount realized by the 
partnership upon the taxable disposition of such property that equals 
the partners' aggregate remaining adjusted basis therein will be 
allocated to the partners in proportion to their respective remaining 
adjusted tax bases in such property. An allocation provided by the 
partnership agreement of the portion of the total amount realized by the 
partnership on its taxable disposition of an oil or gas property that 
exceeds the portion of the total amount realized allocated under either 
of the previous two sentences (whichever is applicable) shall be deemed 
to be made in accordance with the partners' allocable shares of such 
amount realized, provided (c) such allocation does not give rise to 
capital account adjustments under paragraph (b)(2)(iv)(k) of this 
section the economic effect of which is insubstantial (as determined 
under paragraph (b)(2)(ii) of this section), and (d) all other 
allocations and capital account adjustments under the partnership 
agreement are recognized under this paragraph. Otherwise, the partners' 
allocable shares of the total amount realized by the partnership on its 
taxable disposition of an oil or gas property shall be determined in 
accordance with the partners' interests in the partnership under 
paragraph (b)(3) of this section. See example 19 of paragraph (b)(5) of 
this section. (See paragraph (b)(2)(iv)(k) of this section for the 
determination of appropriate adjustments to the partners' capital 
accounts relating to section 613A(c)(7)(D).)
    (vi) Amendments to partnership agreement. If an allocation has 
substantial economic effect under paragraph (b)(2) of this section or is 
deemed to be made in accordance with the partners' interests in the 
partnership under paragraph (b)(4) of this section under the partnership 
agreement that is effective for the taxable year to which such 
allocation relates, and such partnership agreement thereafter is 
modified, both the tax consequences of the modification and the facts 
and circumstances surrounding the modification will be closely 
scrutinized to determine whether the purported modification was part of 
the original agreement. If it is determined that the purported 
modification was part of the original agreement, prior allocations may 
be reallocated in a manner consistent with the modified terms of the 
agreement, and subsequent allocations may be reallocated to take account 
of such modified terms. For example, if a partner is obligated by the 
partnership agreement to restore the deficit balance in his capital 
account (or any limited dollar amount thereof) in accordance with 
requirement (3) of paragraph (b)(2)(ii)(b) of this section and, 
thereafter, such obligation is eliminated or reduced (other than as 
provided in paragraph (b)(2)(ii)(f) of this section), or is not complied 
with in a timely manner, such elimination, reduction, or noncompliance 
may be treated as if it always were part of the partnership agreement 
for purposes of making any reallocations and determining the appropriate 
limitations period.
    (vii) Recapture. For special rules applicable to the allocation of 
recapture

[[Page 317]]

income or credit, see paragraph (e) of Sec. 1.1245-1, paragraph (f) of 
Sec. 1.1250-1, paragraph (c) of Sec. 1.1254-1, and paragraph (a) of 
Sec. 1.47-6.
    (5) Examples. The operation of the rules in this paragraph is 
illustrated by the following examples:

    Example 1. (i) A and B form a general partnership with cash 
contributions of $40,000 each, which cash is used to purchase 
depreciable personal property at a cost of $80,000. The partnership 
elects under section 48(q)(4) to reduce the amount of investment tax 
credit in lieu of adjusting the tax basis of such property. The 
partnership agreement provides that A and B will have equal shares of 
taxable income and loss (computed without regard to cost recovery 
deductions) and cash flow and that all cost recovery deductions on the 
property will be allocated to A. The agreement further provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of the section, but that upon 
liquidation of the partnership, distributions will be made equally 
between the partners (regardless of capital account balances) and no 
partner will be required to restore the deficit balance in his capital 
account for distribution to partners with positive capital accounts 
balances. In the partnership's first taxable year, it recognizes 
operating income equal to its operating expenses and has an additional 
$20,000 cost recovery deduction, which is allocated entirely to A. That 
A and B will be entitled to equal distributions on liquidation, even 
through A is allocated the entire $20,000 cost recovery deduction, 
indicates A will not bear the full risk of the economic loss 
corresponding to such deduction if such loss occurs. Under paragraph 
(b)(2)(ii) of this section, the allocation lacks economic effect and 
will be disregarded. The partners made equal contributions to the 
partnership, share equally in other taxable income and loss and in cash 
flow, and will share equally in liquidation proceeds, indicating that 
their actual economic arrangement is to bear the risk imposed by the 
potential decrease in the value of the property equally. Thus, under 
paragraph (b)(3) of this section the partners' interests in the 
partnership are equal, and the cost recovery deduction will be 
reallocated equally between A and B.
    (ii) Asssume the same facts as in (i) except that the partnership 
agreement provides that liquidation proceeds will be distributed in 
accordance with capital account balances if the partnership is 
liquidated during the first five years of its existence but that 
liquidation proceeds will be distributed equally if the partnership is 
liquidated thereafter. Since the partnership agreement does not provide 
for the requirement contained in paragraph (b)(2)(ii)(b)(2) of this 
section to be satisified throughout the term of the partnership, the 
partnership allocations do not have economic effect. Even if the 
partnership agreement provided for the requirement contained in 
paragraph (b)(2)(ii)(b)(2) to be satisified throughout the term of the 
partnership, such allocations would not have economic effect unless the 
requirement contained in paragraph (b)(2)(ii)(b)(3) of this section or 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section were satisfied.
    (iii) Assume the same facts as in (i) except that distributions in 
liquidation of the partnership (or any partner's interest) are to be 
made in accordance with the partners' positive capital account balances 
throughout the term of the partnership (as set forth in paragraph 
(b)(2)(ii)(b)(2) of this section). Assume further that the partnership 
agreement contains a qualified income offset (as defined in paragraph 
(b)(2)(ii)(d) of this section) and that, as of the end of each 
partnership taxable year, the items described in paragraphs 
(b)(2)(ii)(d)(4), (5), and (6) of this section are not reasonably 
expected to cause or increase a deficit balance in A's capital account.

------------------------------------------------------------------------
                                                        A          B    
------------------------------------------------------------------------
Capital account upon formation....................   $40,000     $40,000
Less: year 1 cost recovery deduction..............   (20,000)          0
                                                   ---------------------
      Capital account at end of year 1............   $20,000     $40,000
------------------------------------------------------------------------

Under the alternate economic effect test contained in paragraph 
(b)(2)(ii)(d) of this section, the allocation of the $20,000 cost 
recovery deduction to A has economic effect.
    (iv) Assume the same facts as in (iii) and that in the partnership's 
second taxable year it recognizes operating income equal to its 
operating expenses and has a $25,000 cost recovery deduction which, 
under the partnership agreement, is allocated entirely to A.

------------------------------------------------------------------------
                                                        A          B    
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000     $40,000
Less: year 2 cost recovery deduction..............   (25,000)          0
                                                   ---------------------
Capital account at end of year 2..................   ($5,000)    $40,000
------------------------------------------------------------------------

    The allocation of the $25,000 cost recovery deduction to A satisfies 
that alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section only to the extent of $20,000. Therefore, only $20,000 
of such allocation has economic effect, and the remaining $5,000 must be 
reallocated in accordance with the partners' interests in the 
partnership. Under the partnership agreement, if the property were sold 
immediately following the end of the partnership's second taxable year 
for $35,000 (its adjusted tax basis), the $35,000 would be distributed 
to B. Thus, B,

[[Page 318]]

and not A, bears the economic burden corresponding to $5,000 of the 
$25,000 cost recovery deduction allocated to A. Under paragraph 
(b)(3)(iii) of this section, $5,000 of such cost recovery deduction will 
be reallocated to B.
    (v) Assume the same facts as in (iv) except that the cost recovery 
deduction for the partnershp's second taxable year is $20,000 instead of 
$25,000. The allocation of such cost recovery deduction to A has 
economic effect under the alternate economic effect test contained in 
paragraph (b)(2)(ii)(d) of this section. Assume further that the 
property is sold for $35,000 immediately following the end of the 
partnership's second taxable year, resulting in a $5,000 taxable loss 
($40,000 adjusted tax basis less $35,000 sales price), and the 
partnership is liquidated.

------------------------------------------------------------------------
                                                        A          B    
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000    $40,000 
Less: year 2 cost recovery dedustion..............   (20,000)         0 
                                                   ---------------------
Capital account at end of year 2..................         0    $40,000 
Less: loss on sale................................    (2,500)    (2,500)
                                                   ---------------------
      Capital account before liquidation..........   ($2,500)   $37,500 
------------------------------------------------------------------------

Under the partnership agreement the $35,000 sales proceeds are 
distributed to B. Since B bears the entire economic burden corresponding 
to the $5,000 taxable loss from the sale of the property, the allocation 
of $2,500 of such loss to A does not have economic effect and must be 
reallocated in accordance with the partners' interests in the 
partnership. Under paragraph (b)(3)(iii) of this section, such $2,500 
loss will be reallocated to B.
    (vi) Assume the same facts as in (iv) except that the cost recovery 
deduction for the partnership's second taxable year is $20,000 instead 
of $25,000, and that as of the end of the partnership's second taxable 
year it is reasonably expected that during its third taxable year the 
partnership will (1) have operating income equal to its operating 
expenses (but will have no cost recovery deductions), (2) borrow $10,000 
(recourse) and distribute such amount $5,000 to A and $5,000 to B, and 
(3) thereafter sell the partnership property, repay the $10,000 
liability, and liquidate. In determining the extent to which the 
alternate economic effect test contained in paragraph (b)(2)(ii)(d) of 
this section is satisfied as of the end of the partnership's second 
taxable year, the fair market value of partnership property is presumed 
to be equal to its adjusted tax basis (in accordance with paragraph 
(b)(2)(iii)(c) of this section). Thus, it is presumed that the selling 
price of such property during the partnership's third taxable year will 
be its $40,000 adjusted tax basis. Accordingly, there can be no 
reasonable expectation that there will be increases to A's capital 
account in the partnership's third taxable year that will offset the 
expected $5,000 distribution to A. Therefore, the distribution of the 
loan proceeds must be taken into account in determining to what extent 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
is satisfied.

------------------------------------------------------------------------
                                                        A          B    
------------------------------------------------------------------------
Capital account at beginning of year 2............   $20,000    $40,000 
Less: expected future distribution................    (5,000)    (5,000)
Less: year 2 cost recovery deduction..............   (20,000)        (0)
                                                   ---------------------
      Hypothetical capital account at end of year                       
       2..........................................   ($5,000)   $35,000 
------------------------------------------------------------------------

Upon sale of the partnership property, the $40,000 presumed sales 
proceeds would be used to repay the $10,000 liability, and the remaining 
$30,000 would be distributed to B. Under these circumstances the 
allocation of the $20,000 cost recovery deduction to A in the 
partnership's second taxable year satisfies the alternate economic 
effect test contained in paragraph (b)(2)(ii)(d) of this section only to 
the extent of $15,000. Under paragraph (b)(3)(iii) of this section, the 
remaining $5,000 of such deduction will be reallocated to B. The results 
in this example would be the same even if the partnership agreement also 
provided that any gain (whether ordinary income or capital gain) upon 
the sale of the property would be allocated to A to the extent of the 
prior allocations of cost recovery deductions to him, and, at end of the 
partnership's second taxable year, the partners were confident that the 
gain on the sale of the property in the partnership's third taxable year 
would be sufficient to offset the expected $5,000 distribution to A.
    (vii) Assume the same facts as in (iv) except that the partnership 
agreement also provides that any partner with a deficit balance in his 
capital account following the liquidation of his interest must restore 
that deficit to the partnership (as set forth in paragraph 
(b)(2)(ii)(b)(3) of this section). Thus, if the property were sold for 
$35,000 immediately after the end of the partnership's second taxable 
year, the $35,000 would be distributed to B, A would contribute $5,000 
(the deficit balance in his capital account) to the partnership, and 
that $5,000 would be distributed to B. The allocation of the entire 
$25,000 cost recovery deduction to A in the partnership's second taxable 
year has economic effect.
    (viii) Assume the same facts as in (vii) except that A's obligation 
to restore the deficit balance in his capital account is limited to a 
maximum of $5,000. The allocation of the $25,000 cost recovery deduction 
to A in the partnership's second taxable year has economic effect under 
the alternate economic

[[Page 319]]

effect test contained in paragraph (b)(2)(ii)(d) of this section. At the 
end of such year, A makes an additional $5,000 contribution to the 
partnership (thereby eliminating the $5,000 deficit balance in his 
capital account). Under paragraph (b)(2)(ii)(f) of this section, A's 
obligation to restore up to $5,000 of the deficit balance in his capital 
account may be eliminated after he contributes the additional $5,000 
without affecting the validity of prior allocations.
    (ix) Assume the same facts as in (iv) except that upon formation of 
the partnership A also contributes to the partnership his negotiable 
promissory note with a $5,000 principal balance. The note 
unconditionally obligates A to pay an additional $5,000 to the 
partnership at the earlier of (a) the beginning of the partnership's 
fourth taxable year, or (b) the end of the partnership taxable year in 
which A's interest is liquidated. Under paragraph (b)(2)(ii)(c) of this 
section, A is considered obligated to restore up to $5,000 of the 
deficit balance in his capital account to the partnership. Accordingly, 
under the alternate economic effect test contained in paragraph 
(b)(2)(ii)(d) of this section, the allocation of the $25,000 cost 
recovery deduction to A in the partnership's second taxable year has 
economic effect. The results in this example would be the same if (1) 
the note A contributed to the partnership were payable only at the end 
of the partnership's fourth taxable year (so that A would not be 
required to satisfy the note upon liquidation of his interest in the 
partnership), and (2) the partnership agreement provided that upon 
liquidation of A's interest, the partnership would retain A's note, and 
A would contribute to the partnership the excess of the outstanding 
principal balance of the note over its then fair market value.
    (x) Assume the same facts as in (ix) except that A's obligation to 
contribute an additional $5,000 to the partnership is not evidenced by a 
promissory note. Instead, the partnership agreement imposes upon A the 
obligation to make an additional $5,000 contribution to the partnership 
at the earlier of (a) the beginning of the partnership's fourth taxable 
year, or (b) the end of the partnership taxable year in which A's 
interest is liquidated. Under paragraph (b)(2)(ii)(c) of this section, 
as a result of A's deferred contribution requirement, A is considered 
obligated to restore up to $5,000 of the deficit balance in his capital 
account to the partnership. Accordingly, under the alternate economic 
effect test contained in paragraph (b)(2)(ii)(d) of this section, the 
allocation of the $25,000 cost recovery deduction to A in the 
partnership's second taxable year has economic effect.
    (xi) Assume the same facts as in (vii) except that the partnership 
agreement also provides that any gain (whether ordinary income or 
capital gain) upon the sale of the property will be allocated to A to 
the extent of the prior allocations to A of cost recovery deductions 
from such property, and additional gain will be allocated equally 
between A and B. At the time the allocations of cost recovery deductions 
were made to A, the partners believed there would be gain on the sale of 
the property in an amount sufficient to offset the allocations of cost 
recovery deductions to A. Nevertheless, the existence of the gain 
chargeback provision will not cause the economic effect of the 
allocations to be insubstantial under paragraph (b)(2)(iii)(c) of this 
section, since in testing whether the economic effect of such 
allocations is substantial, the recovery property is presumed to 
decrease in value by the amount of such deductions.
    Example 2. C and D form a general partnership solely to acquire and 
lease machinery that is 5-year recovery property under section 168. Each 
contributes $100,000, and the partnership obtains an $800,000 recourse 
loan to purchase the machinery. The partnership elects under section 
48(q)(4) to reduce the amount of investment tax credit in lieu of 
adjusting the tax basis of such machinery. The partnership, C, and D 
have calendar taxable years. The partnership agreement provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of this section, distributions in 
liquidation of the partnership (or any partner's interest) will be made 
in accordance with the partners' positive capital account balances, and 
any partner with a deficit balance in his capital account following the 
liquidation of his interest must restore that deficit to the partnership 
(as set forth in paragraphs (b)(2)(ii)(b)(2) and (3) of this section). 
The partnership agreement further provides that (a) partnership net 
taxable loss will be allocated 90 percent to C and 10 percent to D until 
such time as there is partnership net taxable income, and therefore C 
will be allocated 90 percent of such taxable income until he has been 
allocated partnership net taxable income equal to the partnership net 
taxable loss previously allocated to him, (b) all further partnership 
net taxable income or loss will be allocated equally between C and D, 
and (c) distributions of operating cash flow will be made equally 
between C and D. The partnership enters into a 12-year lease with a 
financially secure corporation under which the partnership expects to 
have a net taxable loss in each of its first 5 partnership taxable years 
due to cost recovery deductions with respect to the machinery and net 
taxable income in each of its following 7 partnership taxable years, in 
part due to the absence of such cost recovery deductions. There is a 
strong likelihood that the partnership's net taxable loss in partnership 
taxable years 1 through 5 will be $100,000, $90,000, $80,000, $70,000, 
and $60,000,

[[Page 320]]

respectively, and the partnership's net taxable income in partnership 
taxable years 6 through 12 will be $40,000, $50,000, $60,000, $70,000, 
$80,000, $90,000, and $100,000, respectively. Even though there is a 
strong likelihood that the allocations of net taxable loss in years 1 
through 5 will be largely offset by other allocations in partnership 
taxable years 6 through 12, and even if it is assumed that the total tax 
liability of the partners in years 1 through 12 will be less than if the 
allocations had not been provided in the partnership agreement, the 
economic effect of the allocations will not be insubstantial under 
paragraph (b)(2)(iii)(c) of this section. This is because at the time 
such allocations became part of the partnership agreement, there was a 
strong likelihood that the allocations of net taxable loss in years 1 
through 5 would not be largely offset by allocations of income within 5 
years (determined on a first-in, first-out basis). The year 1 allocation 
will not be offset until years 6, 7, and 8, the year 2 allocation will 
not be offset until years 8 and 9, the year 3 allocation will not be 
offset until years 9 and 10, the year 4 allocation will not be offset 
until years 10 and 11, and the year 5 allocation will not be offset 
until years 11 and 12.
    Example 3. E and F enter into a partnership agreement to develop and 
market experimental electronic devices. E contributes $2,500 cash and 
agrees to devote his full-time services to the partnership. F 
contributes $100,000 cash and agrees to obtain a loan for the 
partnership for any additional capital needs. The partnership agreement 
provides that all deductions for research and experimental expenditures 
and interest on partnership loans are to be allocated to F. In addition, 
F will be allocated 90 percent, and E 10 percent, of partnership taxable 
income or loss, computed net of the deductions for such research and 
experimental expenditures and interest, until F has received allocations 
of such taxable income equal to the sum of such research and 
experimental expenditures, such interest expense, and his share of such 
taxable loss. Thereafter, E and F will share all taxable income and loss 
equally. Operating cash flow will be distributed equally between E and 
F. The partnership agreement also provides that E's and F's capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of his 
interest must restore that deficit to the partnership (as set forth in 
paragraphs (b)(2)(ii)(b)(2) and (3) of this section). These allocations 
have economic effect. In addition, in view of the nature of the 
partnership's activities, there is not a strong likelihood at the time 
the allocations become part of the partnership agreement that the 
economic effect of the allocations to F of deductions for research and 
experimental expenditures and interest on partnership loans will be 
largely offset by allocations to F of partnership net taxable income. 
The economic effect of the allocations is substantial.
    Example 4. (i) G and H contribute $75,000 and $25,000, respectively, 
in forming a general partnership. The partnership agreement provides 
that all income, gain, loss, and deduction will be allocated equally 
between the partners, that the partners' capital accounts will be 
determined and maintained in accordance with paragraph (b)(2)(iv) of 
this section, but that all partnership distributions will, regardless of 
capital account balances, be made 75 percent to G and 25 percent to H. 
Following the liquidation of the partnership, neither partner is 
required to restore the deficit balance in his capital account to the 
partnership for distribution to partners with positive capital account 
balances. The allocations in the partnership agreement do not have 
economic effect. Since contributions were made in a 75/25 ratio and the 
partnership agreement indicates that all economic profits and losses of 
the partnership are to be shared in a 75/25 ratio, under paragraph 
(b)(3) of this section, partnership income, gain, loss, and deduction 
will be reallocated 75 percent to G and 25 percent to H.
    (ii) Assume the same facts as in (i) except that the partnership 
maintains no capital accounts and the partnership agreement provides 
that all income, gain, loss, deduction, and credit will be allocated 75 
percent to G and 25 percent to H. G and H are ultimately liable (under a 
State law right of contribution) for 75 percent and 25 percent, 
respectively, of any debts of the partnership. Although the allocations 
do not satisfy the requirements of paragraph (b)(2)(ii)(b) of this 
section, the allocations have economic effect under the economic effect 
equivalence test of paragraph (b)(2)(ii)(i) of this section.
    (iii) Assume the same facts as in (i) except that the partnership 
agreement provides that any partner with a deficit balance in his 
capital account must restore that deficit to the partnership (as set 
forth in paragraph (b)(2)(ii)(b)(2) of this section). Although the 
allocations do not satisfy the requirements of paragraph (b)(2)(ii)(b) 
of this section, the allocations have economic effect under the economic 
effect equivalence test of paragraph (b)(2)(ii)(i) of this section.
    Example 5. (i) Individuals I and J are the only partners of an 
investment partnership. The partnership owns corporate stocks, corporate 
debt instruments, and tax-exempt debt instruments. Over the next several 
years, I expects to be in the 50 percent marginal tax bracket, and J 
expects to be in the 15 percent marginal tax bracket. There is a

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strong likelihood that in each of the next several years the partnership 
will realize between $450 and $550 of tax-exempt interest and between 
$450 and $550 of a combination of taxable interest and dividends from 
its investments. I and J made equal capital contributions to the 
partnership, and they have agreed to share equally in gains and losses 
from the sale of the partnership's investment securities. I and J agree, 
however, that rather than share interest and dividends of the 
partnership equally, they will allocate the partnership's tax-exempt 
interest 80 percent to I and 20 percent to J and will distribute cash 
derived from interest received on the tax-exempt bonds in the same 
percentages. In addition, they agree to allocate 100 percent of the 
partnership's taxable interest and dividends to J and to distribute cash 
derived from interest and dividends received on the corporate stocks and 
debt instruments 100 percent to J. The partnership agreement further 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partner's positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The allocation of taxable interest and 
dividends and tax-exempt interest has economic effect, but that economic 
effect is not substantial under the general rules set forth in paragraph 
(b)(2)(iii) of this section. Without the allocation I would be allocated 
between $225 and $275 of tax-exempt interest and between $225 and $275 
of a combination of taxable interest and dividends, which (net of 
Federal income taxes he would owe on such income) would give I between 
$337.50 and $412.50 after tax. With the allocation, however, I will be 
allocated between $360 and $440 of tax-exempt interest and no taxable 
interest and dividends, which (net of Federal income taxes) will give I 
between $360 and $440 after tax. Thus, at the time the allocations 
became part of the partnership agreement, I is expected to enhance his 
after-tax economic consequences as a result of the allocations. On the 
other hand, there is a strong likelihood that neither I nor J will 
substantially diminish his after-tax economic consequences as a result 
of the allocations. Under the combination of likely investment outcomes 
least favorable for J, the partnership would realize $550 of tax-exempt 
interest and $450 of taxable interest and dividends, giving J $492.50 
after tax (which is more than the $466.25 after tax J would have 
received if each of such amounts had been allocated equally between the 
partners). Under the combination of likely investment outcomes least 
favorable for I, the partnership would realize $450 of tax-exempt 
interest and $550 of taxable interest and dividends, giving I $360 after 
tax (which is not substantially less than the $362.50 he would have 
received if each of such amounts had been allocated equally between the 
partners). Accordingly, the allocations in the partnership agreement 
must be reallocated in accordance with the partners' interests in the 
partnership under paragraph (b)(3) of this section.
    (ii) Assume the same facts as in (i). In addition, assume that in 
the first partnership taxable year in which the allocation arrangement 
described in (i) applies, the partnership realizes $450 of tax-exempt 
interest and $550 of taxable interest and dividends, so that, pursuant 
to the partnership agreement, I's capital account is credited with $360 
(80 percent of the tax-exempt interest), and J's capital account is 
credited with $640 (20 percent of the tax-exempt interest and 100 
percent of the taxable interest and dividends). The allocations of tax-
exempt interest and taxable interest and dividends (which do not have 
substantial economic effect for the reasons stated in (i) will be 
disregarded and will be reallocated. Since under the partnership 
agreement I will receive 36 percent (360/1,000) and J will receive 64 
percent (640/1,000) of the partnership's total investment income in such 
year, under paragraph (b)(3) of this section the partnership's tax-
exempt interest and taxable interest and dividends each will be 
reallocated 36 percent to I and 64 percent to J.
    Example 6. K and L are equal partners in a general partnership 
formed to acquire and operate property described in section 1231(b). The 
partnership, K, and L have calendar taxable years. The partnership 
agreement provides that the partners' capital accounts will be 
determined and maintained in accordance with paragraph (b)(2)(iv) of 
this section, that distributions in liquidation of the partnership (or 
any partner's interest) will be made in accordance with the partners' 
positive capital account balances, and that any partner with a deficit 
balance in his capital account following the liquidation of his interest 
must restore that deficit to the partnership (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). For a taxable year in which 
the partnership expects to incur a loss on the sale of a portion of such 
property, the partnership agreement is amended (at the beginning of the 
taxable year) to allocate such loss to K, who expects to have no gains 
from the sale of depreciable property described in section 1231(b) in 
that taxable year, and to allocate an equivalent amount of partnership 
loss and deduction for that year of a different character to L, who 
expects to have such gains. Any partnership loss and deduction in excess 
of these allocations will be allocated equally between K and L. The 
amendment is effective only for that

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taxable year. At the time the partnership agreement is amended, there is 
a strong likelihood that the partnership will incur deduction or loss in 
the taxable year other than loss from the sale of property described in 
section 1231(b) in an amount that will substantially equal or exceed the 
expected amount of the section 1231(b) loss. The allocations in such 
taxable year have economic effect. However, the economic effect of the 
allocations is insubstantial under the test described in paragraph 
(b)(2)(iii) (b) of this section because there is a strong likelihood, at 
the time the allocations become part of the partnership agreement, that 
the net increases and decreases to K's and L's capital accounts will be 
the same at the end of the taxable year to which they apply with such 
allocations in effect as they would have been in the absence of such 
allocations, and that the total taxes of K and L for such year will be 
reduced as a result of such allocations. If in fact the partnership 
incurs deduction or loss, other than loss from the sale of property 
described in section 1231(b), in an amount at least equal to the section 
1231(b) loss, the loss and deduction in such taxable year will be 
reallocated equally between K and L under paragraph (b)(3) of this 
section. If not, the loss from the sale of property described in section 
1231(b) and the items of deduction and other loss realized in such year 
will be reallocated between K and L in proportion to the net decreases 
in their capital accounts due to the allocation of such items under the 
partnership agreement.
    Example 7. (i) M and N are partners in the MN general partnership, 
which is engaged in an active business. Income, gain, loss, and 
deduction from MN's business is allocated equally between M and N. The 
partnership, M, and N have calendar taxable years. Under the partnership 
agreement the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partner's positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). In order to enhance the credit standing of the 
partnership, the partners contribute surplus funds to the partnership, 
which the partners agree to invest in equal dollar amounts of tax-exempt 
bonds and corporate stock for the partnership's first 3 taxable years. M 
is expected to be in a higher marginal tax bracket than N during those 3 
years. At the time the decision to make these investments is made, it is 
agreed that, during the 3-year period of the investment, M will be 
allocated 90 percent and N 10 percent of the interest income from the 
tax-exempt bonds as well as any gain or loss from the sale thereof, and 
that M will be allocated 10 percent and N 90 percent of the dividend 
income from the corporate stock as well as any gain or loss from the 
sale thereof. At the time the allocations concerning the investments 
become part of the partnership agreement, there is not a strong 
likelihood that the gain or loss from the sale of the stock will be 
substantially equal to the gain or loss from the sale of the tax-exempt 
bonds, but there is a strong likelihood that the tax-exempt interest and 
the taxable dividends realized from these investments during the 3-year 
period will not differ substantially. These allocations have economic 
effect, and the economic effect of the allocations of the gain or loss 
on the sale of the tax-exempt bonds and corporate stock is substantial. 
The economic effect of the allocations of the tax-exempt interest and 
the taxable dividends, however, is not substantial under the test 
described in paragraph (b)(2)(iii)(c) of this section because there is a 
strong likelihood, at the time the allocations become part of the 
partnership agreement, that at the end of the 3-year period to which 
such allocations relate, the net increases and decreases to M's and N's 
capital accounts will be the same with such allocations as they would 
have been in the absence of such allocations, and that the total taxes 
of M and N for the taxable years to which such allocations relate will 
be reduced as a result of such allocations. If in fact the amounts of 
the tax-exempt interest and taxable dividends earned by the partnership 
during the 3-year period are equal, the tax-exempt interest and taxable 
dividends will be reallocated to the partners in equal shares under 
paragraph (b)(3) of this section. If not, the tax-exempt interest and 
taxable dividends will be reallocated between M and N in proportion to 
the net increases in their capital accounts during such 3-year period 
due to the allocation of such items under the partnership agreement.
    (ii) Assume the same facts as in (i) except that gain or loss from 
the sale of the tax-exempt bonds and corporate stock will be allocated 
equally between M and N and the partnership agreement provides that the 
90/10 allocation arrangement with respect to the investment income 
applies only to the first $10,000 of interest income from the tax-exempt 
bonds and the first $10,000 of dividend income from the corporate stock, 
and only to the first taxable year of the partnership. There is a strong 
likelihood at the time the 90/10 allocation of the investment income 
became part of the partnership agreement that in the first taxable year 
of the partnership, the partnership will earn more than $10,000 of tax-
exempt interest and more than $10,000 of taxable dividends. The 
allocations of tax-exempt interest and taxable dividends provided in the 
partnership agreement have economic effect, but under the test contained 
in

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paragraph (b)(2)(iii)(b) of this section, such economic effect is not 
substantial for the same reasons stated in (i) (but applied to the 1 
taxable year, rather than to a 3-year period). If in fact the 
partnership realizes at least $10,000 of tax-exempt interest and at 
least $10,000 of taxable dividends in such year, the allocations of such 
interest income and dividend income will be reallocated equally between 
M and N under paragraph (b)(3) of this section. If not, the tax-exempt 
interest and taxable dividends will be reallocated between M and N in 
proportion to the net increases in their capital accounts due to the 
allocations of such items under the partnership agreement.
    (iii) Assume the same facts as in (ii) except that at the time the 
90/10 allocation of investment income becomes part of the partnership 
agreement, there is not a strong likelihood that (1) the partnership 
will earn $10,000 or more of tax-exempt interest and $10,000 or more of 
taxable dividends in the partnership's first taxable year, and (2) the 
amount of tax-exempt interest and taxable dividends earned during such 
year will be substantially the same. Under these facts the economic 
effect of the allocations generally will be substantial. (Additional 
facts may exist in certain cases, however, so that the allocation is 
insubstantial under the second sentence of paragraph (b)(2)(iii). See 
example 5 above.)
    Example 8. (i) O and P are equal partners in the OP general 
partnership. The partnership, O, and P have calendar taxable years. 
Partner O has a net operating loss carryover from another venture that 
is due to expire at the end of the partnership's second taxable year. 
Otherwise, both partners expect to be in the 50 percent marginal tax 
bracket in the next several taxable years. The partnership agreement 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partners' positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore that 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The partnership agreement is amended (at the 
beginning of the partnership's second taxable year) to allocate all the 
partnership net taxable income for that year to O. Future partnership 
net taxable loss is to be allocated to O, and future partnership net 
taxable income to P, until the allocation of income to O in the 
partnership's second taxable year is offset. It is further agreed orally 
that in the event the partnership is liquidated prior to completion of 
such offset, O's capital account will be adjusted downward to the extent 
of one-half of the allocations of income to O in the partnership's 
second taxable year that have not been offset by other allocations, P's 
capital account will be adjusted upward by a like amount, and 
liquidation proceeds will be distributed in accordance with the 
partners' adjusted capital account balances. As a result of this oral 
amendment, all allocations of partnership net taxable income and net 
taxable loss made pursuant to the amendment executed at the beginning of 
the partnership's second taxable year lack economic effect and will be 
disregarded. Under the partnership agreement other allocations are made 
equally to O and P, and O and P will share equally in liquidation 
proceeds, indicating that the partners' interests in the partnership are 
equal. Thus, the disregarded allocations will be reallocated equally 
between the partners under paragraph (b)(3) of this section.
    (ii) Assume the same facts as in (i) except that there is no 
agreement that O's and P's capital accounts will be adjusted downward 
and upward, respectively, to the extent of one-half of the partnership 
net taxable income allocated to O in the partnership's second taxable 
year that is not offset subsequently by other allocations. The income of 
the partnership is generated primarily by fixed interest payments 
received with respect to highly rated corporate bonds, which are 
expected to produce sufficient net taxable income prior to the end of 
the partnership's seventh taxable year to offset in large part the net 
taxable income to be allocated to O in the partnership's second taxable 
year. Thus, at the time the allocations are made part of the partnership 
agreement, there is a strong likelihood that the allocation of net 
taxable income to be made to O in the second taxable year will be offset 
in large part within 5 taxable years thereafter. These allocations have 
economic effect. However, the economic effect of the allocation of 
partnership net taxable income to O in the partnership's second taxable 
year, as well as the offsetting allocations to P, is not substantial 
under the test contained in paragraph (b)(2)(iii)(c) of this section 
because there is a strong likelihood that the net increases or decreases 
in O's and P's capital accounts will be the same at the end of the 
partnership's seventh taxable year with such allocations as they would 
have been in the absence of such allocations, and the total taxes of O 
and P for the taxable years to which such allocations relate will be 
reduced as a result of such allocations. If in fact the partnership, in 
its taxable years 3 through 7, realizes sufficient net taxable income to 
offset the amount allocated to O in the second taxable year, the 
allocations provided in the partnership agreement will be reallocated 
equally between the partners under paragraph (b)(3) of this section.
    Example 9. Q and R form a limited partnership with contributions of 
$20,000 and

[[Page 324]]

$180,000, respectively. Q, the limited partner, is a corporation that 
has $2,000,000 of net operating loss carryforwards that will not expire 
for 8 years. Q does not expect to have sufficient income (apart from the 
income of the partnership) to absorb any of such net operating loss 
carryforwards. R, the general partner, is a corporation that expects to 
be in the 46 percent marginal tax bracket for several years. The 
partnership agreement provides that the partners' capital accounts will 
be determined and maintained in accordance with paragraph (b)(2)(iv) of 
this section, distributions in liquidation of the partnership (or any 
partner's interest) will be made in accordance with the partners' 
positive capital account balances, and any partner with a deficit 
balance in his capital account following the liquidation of his interest 
must restore that deficit to the partnership (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). The partnership's cash, 
together with the proceeds of an $800,000 loan, are invested in assets 
that are expected to produce taxable income and cash flow (before debt 
service) of approximately $150,000 a year for the first 8 years of the 
partnership's operations. In addition, it is expected that the 
partnership's total taxable income in its first 8 taxable years will not 
exceed $2,000,000. The partnership's $150,000 of cash flow in each of 
its first 8 years will be used to retire the $800,000 loan. The 
partnership agreement provides that partnership net taxable income will 
be allocated 90 percent to Q and 10 percent to R in the first through 
eighth partnership taxable years, and 90 percent to R and 10 percent to 
Q in all subsequent partnership taxable years. Net taxable loss will be 
allocated 90 percent to R and 10 percent to Q in all partnership taxable 
years. All distributions of cash from the partnership to partners (other 
than the priority distributions to Q described below) will be made 90 
percent to R and 10 percent to Q. At the end of the partnership's eighth 
taxable year, the amount of Q's capital account in excess of one-ninth 
of R's capital account on such date will be designated as Q's ``excess 
capital account.'' Beginning in the ninth taxable year of the 
partnership, the undistributed portion of Q's excess capital account 
will begin to bear interest (which will be paid and deducted under 
section 707(c) at a rate of interest below the rate that the partnership 
can borrow from commercial lenders, and over the next several years 
(following the eight year) the partnership will make priority cash 
distributions to Q in prearranged percentages of Q's excess capital 
account designed to amortize Q's excess capital account and the interest 
thereon over a prearranged period. In addition, the partnership's 
agreement prevents Q from causing his interest in the partnership from 
being liquidated (and thereby receiving the balance in his capital 
account) without R's consent until Q's excess capital account has been 
eliminated. The below market rate of interest and the period over which 
the amortization will take place are prescribed such that, as of the end 
of the partnership's eighth taxable year, the present value of Q's right 
to receive such priority distributions is approximately 46 percent of 
the amount of Q's excess capital account as of such date. However, 
because the partnership's income for its first 8 taxable years will be 
realized approximately ratably over that period, the present value of 
Q's right to receive the priority distributions with respect to its 
excess capital account is, as of the date the partnership agreement is 
entered into, less than the present value of the additional Federal 
income taxes for which R would be liable if, during the partnership's 
first 8 taxable years, all partnership income were to be allocated 90 
percent to R and 10 to Q. The allocations of partnership taxable income 
to Q and R in the first through eighth partnership taxable years have 
economic effect. However, such economic effect is not substantial under 
the general rules set forth in paragraph (b)(2)(iii) of this section. 
This is true because R may enhance his after-tax economic consequences, 
on a present value basis, as a result of the allocations to Q of 90 
percent of partnership's income during taxable years 1 through 8, and 
there is a strong likelihood that neither R nor Q will substantially 
diminish its after-tax economic consequences, on a present value basis, 
as a result of such allocation. Accordingly, partnership taxable income 
for partnership taxable years 1 through 8 will be reallocated in 
accordance with the partners' interests in the partnership under 
paragraph (b)(3) of this section.
    Example 10. (i) S and T form a general partnership to operate a 
travel agency. The partnership agreement provides that the partners' 
capital accounts will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, distributions in liquidation of 
the partnership (or any partner's interest) will be made in accordance 
with the partners' positive capital account balances, and any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraphs (b)(2)(ii)(b) (2) and (3) of this section). The 
partnership agreement provides that T, a resident of a foreign country, 
will be allocated 90 percent, and S 10 percent, of the income, gain, 
loss, and deduction derived from operations conducted by T within his 
country, and all remaining income, gain, loss, and deduction will be 
allocated equally. The amount of such income, gain, loss, or deduction 
cannot be predicted with any reasonable certainty. The allocations 
provided by the partnership agreement have substantial economic effect.

[[Page 325]]

    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that all income, gain, loss, and deduction of the 
partnership will be shared equally, but that T will be allocated all 
income, gain, loss, and deduction derived from operations conducted by 
him within his country as a part of his equal share of partnership 
income, gain, loss, and deduction, upon to the amount of such share. 
Assume the total tax liability of S and T for each year to which these 
allocations relate will be reduced as a result of such allocation. These 
allocations have economic effect. However, such economic effect is not 
substantial under the test stated in paragraph (b)(2)(iii)(b) of this 
section because, at the time the allocations became part of the 
partnership agreement, there is a strong likelihood that the net 
increases and decreases to S's and T's capital accounts will be the same 
at the end of each partnership taxable year with such allocations as 
they would have been in the absence of such allocations, and that the 
total tax liability of S and T for each year to which such allocations 
relate will be reduced as a result of such allocations. Thus, all items 
of partnership income, gain, loss, and income, gain, loss, and deduction 
will be reallocated equally between S and T under paragraph (b)(3) of 
this section.
    Example 11. (i) U and V share equally all income, gain, loss, and 
deduction of the UV general partnership, as well as all non-liquidating 
distributions made by the partnership. The partnership agreement 
provides that the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section, 
distributions in liquidation of the partnership (or any partner's 
interest) will be made in accordance with the partners' positive capital 
account balances, and any partner with a deficit balance in his capital 
account following the liquidation of his interest must restore such 
deficit to the partnership (as set forth in paragraphs (b)(2)(ii)(b) (2) 
and (3) of this section). The agreement further provides that the 
partners will be allocated equal shares of any section 705(a)(2)(B) 
expenditures of the partnership. In the partnership's first taxable 
year, it pays qualified first-year wages of $6,000 and is entitled to a 
$3,000 targeted jobs tax credit under sections 44B and 51 of the Code. 
Under section 280C the partnership must reduce its deduction for wages 
paid by the $3,000 credit claimed (which amount constitutes a section 
705(a)(2)(B) expenditure). The partnership agreement allocates the 
credit to U. Although the allocations of wage deductions and section 
705(a)(2)(B) expenditures have substantial economic effect, the 
allocation of tax credit cannot have economic effect since it cannot 
properly be reflected in the partners' capital accounts. Furthermore, 
the allocation is not in accordance with the special partners' interests 
in the partnership rule contained in paragraph (b)(4)(ii) of this 
section. Under that rule, since the expenses that gave rise to the 
credit are shared equally by the partners, the credit will be shared 
equally between U and V.
    (ii) Assume the same facts as in (i) and that at the beginning of 
the partnership's second taxable year, the partnership agreement is 
amended to allocate to U all wage expenses incurred in that year 
(including wage expenses that constitute section 705(a)(2)(B) 
expenditures) whether or not such wages qualify for the credit. The 
partnership agreement contains no offsetting allocations. That taxable 
year the partnership pays $8,000 in total wages to its employees. Assume 
that the partnership has operating income equal to its operating 
expenses (exclusive of expenses for wages). Assume further that $6,000 
of the $8,000 wage expense constitutes qualified first-year wages. U is 
allocated the $3,000 deduction and the $3,000 section 705(a)(2)(B) 
expenditure attributable to the $6,000 of qualified first-year wages, as 
well as the deduction for the other $2,000 in wage expenses. The 
allocations of wage deductions and section 705(a)(2)(B) expenditures 
have substantial economic effect. Furthermore, since the wage credit is 
allocated in the same proportion as the expenses that gave rise to the 
credit, and the allocation of those expenses has substantial economic 
effect, the allocation of such credit to U is in accordance with the 
special partners' interests in the partnership rule contained in 
paragraph (b)(4)(ii) of this section and is recognized thereunder.
    Example 12. (i) W and X form a general partnership for the purpose 
of mining iron ore. W makes an initial contribution of $75,000, and X 
makes an initial contribution of $25,000. The partnership agreement 
provides that non-liquidating distributions will be made 75 percent to W 
and 25 percent to X, and that all items of income, gain, loss, and 
deduction will be allocated 75 percent to W and 25 percent to X, except 
that all percentage depletion deductions will be allocated to W. The 
agreement further provides that the partners' capital accounts will be 
determined and maintained in accordance with paragraphs (b)(2)(iv) of 
this section, distributions in liquidation of the partnership (or any 
partner's interest) will be made in accordance with the partners' 
positive capital account balances, and any partner with a deficit 
balance in his capital account following the liquidation of his interest 
must restore such deficit to the partnership (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). Assume that the adjusted tax 
basis of the partnership's only depletable iron ore property is $1,000 
and that the percentage depletion deduction for the taxable year with 
respect to such property is $1,500. The allocation of partnership 
income, gain,

[[Page 326]]

loss, and deduction (excluding the percentage depletion deduction) as 
well as the allocation of $1,000 of the percentage depletion deduction 
have substantial economic effect. The allocation to W of the remaining 
$500 of the percentage depletion deduction, representing the excess of 
percentage depletion over adjusted tax basis of the iron ore property, 
cannot have economic effect since such amount cannot properly be 
reflected in the partners' capital accounts. Furthermore, the allocation 
to W of that $500 excess percentage depletion deduction is not in 
accordance with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(iii) of this section, under which such 
$500 excess depletion deduction (and all further percentage depletion 
deductions from the mine) will be reallocated 75 percent to W and 25 
percent to X.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that all percentage depletion deductions of the 
partnership will be allocated 75 percent to W and 25 percent to X. Once 
again, the allocation of partnership income, gain, loss, and deduction 
(excluding the percentage depletion deduction) as well as the allocation 
of $1,000 of the percentage depletion deduction have substantial 
economic effect. Furthermore, since the $500 portion of the percentage 
depletion deduction that exceeds the adjusted basis of such iron ore 
property is allocated in the same manner as valid allocations of the 
gross income from such property during the taxable year (i.e., 75 
percent to W and 25 percent to X), the allocation of the $500 excess 
percentage depletion contained in the partnership agreement is in 
accordance with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(iii) of this section.
    Example 13. (i) Y and Z form a brokerage general partnership for the 
purpose of investing and trading in marketable securities. Y contributes 
cash of $10,000, and Z contributes securities of P corporation, which 
have an adjusted basis of $3,000 and a fair market value of $10,000. The 
partnership would not be an investment company under section 351(e) if 
it were incorporated. The partnership agreement provides that the 
partners' capital accounts will be determined and maintained in 
accordance with paragraph (b)(2)(iv) of this section, distributions in 
liquidation of the partnership (or any partner's interest) will be made 
in accordance with the partners' positive capital account balances, and 
any partner with a deficit balance in his capital account following the 
liquidation of his interest must restore that deficit to the partnership 
(as set forth in paragraphs (b)(2)(ii)(b) (2) and (3) of this section). 
The partnership uses the interim closing of the books method for 
purposes of section 706. The initial capital accounts of Y and Z are 
fixed at $10,000 each. The agreement further provides that all 
partnership distributions, income, gain, loss, deduction, and credit 
will be shared equally between Y and Z, except that the taxable gain 
attributable to the precontribution appreciation in the value of the 
securities of P corporation will be allocated to Z in accordance with 
section 704(c). During the partnership's first taxable year, it sells 
the securities of P corporation for $12,000, resulting in a $2,000 book 
gain ($12,000 less $10,000 book value) and a $9,000 taxable gain 
($12,000 less $3,000 adjusted tax basis). The partnership has no other 
income, gain, loss, or deductions for the taxable year. The gain from 
the sale of the securities is allocated as follows:

------------------------------------------------------------------------
                                           Y                   Z        
                                 ---------------------------------------
                                     Tax      Book       Tax      Book  
------------------------------------------------------------------------
Capital account upon formation..   $10,000   $10,000    $3,000   $10,000
Plus: gain......................     1,000     1,000     8,000     1,000
                                 ---------------------------------------
      Capital account at end of                                         
       year 1...................   $11,000   $11,000   $11,000   $11,000
------------------------------------------------------------------------

The allocation of the $2,000 book gain, $1,000 each to Y and Z, has 
substantial economic effect. Furthermore, under section 704(c) the 
partners' distributive shares of the $9,000 taxable gain are $1,000 to Y 
and $8,000 to Z.
    (ii) Assume the same facts as in (i) and that at the beginning of 
the partnership's second taxable year, it invests its $22,000 of cash in 
securities of G Corp. The G Corp. securities increase in value to 
$40,000, at which time Y sells 50 percent of his partnership interest 
(i.e., a 25 percent interest in the partnership) to LK for $10,000. The 
partnership does not have a section 754 election in effect for the 
partnership taxable year during which such sale occurs. In accordance 
with paragraph (b)(2)(iv)(l) of this section, the partnership agreement 
provides that LK inherits 50 percent of Y's $11,000 capital account 
balance. Thus, following the sale, LK and Y each have a capital account 
of $5,500, and Z's capital account remains at $11,000. Prior to the end 
of the partnership's second taxable year, the securities are sold for 
their $40,000 fair market value, resulting in an $18,000 taxable gain 
($40,000 less $22,000 adjusted tax basis). The partnership has no other 
income, gain, loss, or deduction in such taxable year. Under the 
partnership agreement the $18,000 taxable gain is allocated as follows:

------------------------------------------------------------------------
                                                Y         Z        LK   
------------------------------------------------------------------------
Capital account before sale of securities.    $5,500   $11,000    $5,500
Plus: gain................................     4,500     9,000     4,500
                                           -----------------------------

[[Page 327]]

                                                                        
      Capital account at end of year 2....   $10,000   $20,000   $10,000
------------------------------------------------------------------------

    The allocation of the $18,000 taxable gain has substantial economic 
effect.
    (iii) Assume the same facts as in (ii) except that the partnership 
has a section 754 election in effect for the partnership taxable year 
during which Y sells 50 percent of his interest to LK. Accordingly, 
under Sec. 1.743-1 there is a $4,500 basis increase to the G Corp. 
securities with respect to LK. Notwithstanding this basis adjustment, as 
a result of the sale of the G Corp. securities, LK's capital account is, 
as in (ii), increased by $4,500. The fact that LK recognizes no taxable 
gain from such sale (due to his $4,500 section 743 basis adjustment) is 
irrelevant for capital accounting purposes since, in accordance with 
paragraph (b)(2)(iv)(m)(2) of this section, that basis adjustment is 
disregarded in the maintenance and computation of the partners' capital 
accounts.
    (iv) Assume the same facts as in (iii) except that immediately 
following Y's sale of 50 percent of this interest to LK, the G Corp. 
securities decrease in value to $32,000 and are sold. The $10,000 
taxable gain ($32,000 less $22,000 adjusted tax basis) is allocated as 
follows:

------------------------------------------------------------------------
                                                Y         Z        LK   
------------------------------------------------------------------------
Capital account before sale of securities.    $5,500   $11,000    $5,500
Plus: gain................................     2,500     5,000     2,500
                                           -----------------------------
      Capital account at end of the year 2    $8,000   $16,000    $8,000
------------------------------------------------------------------------

    The fact that LK recognizes a $2,000 taxable loss from the sale of 
the G Corp. securities (due to his $4,500 section 743 basis adjustment) 
is irrelevant for capital accounting purposes since, in accordance with 
paragraph (b)(2)(iv)(m)(2) of this section, that basis adjustment is 
disregarded in the maintenance and computation of the partners' capital 
accounts.
    (v) Assume the same facts as in (ii) except that Y sells 100 percent 
of his partnership interest (i.e., a 50 percent interest in the 
partnership) to LK for $20,000. Under section 708(b)(1)(B) the 
partnership terminates. Under paragraph (b)(1)(iv) of Sec. 1.708-1, 
there is a constructive liquidation of the partnership. Immediately 
preceding the constructive liquidation, the capital accounts of Z and LK 
equal $11,000 each (LK having inherited Y's $11,000 capital account). In 
accordance with paragraph (b)(2)(iv)(e) of this section, the partnership 
agreement provides that the partners' capital accounts are adjusted to 
reflect how unrealized taxable gain would have been allocated if the 
securities had been sold for their $40,000 fair market value. 
Accordingly, the $18,000 of unrealized gain ($40,000 less $22,000 
adjusted tax basis is credited to the partners' capital accounts as 
follows:

------------------------------------------------------------------------
                                                        Z          LK   
------------------------------------------------------------------------
Capital account following sale....................    $11,000    $11,000
Deemed sale adjustment............................      9,000      9,000
                                                   ---------------------
      Capital account before constructive                               
       liquidation................................    $20,000    $20,000
------------------------------------------------------------------------

Constructive liquidating distributions of the securities are made with 
reference to their $40,000 fair market value. Under section 732(b) the 
adjusted tax basis of the G Corp. securities constructively distributed 
to Z is equal to the $11,000 adjusted tax basis of Z's partnership 
interest before the constructive liquidation, and the adjusted tax basis 
of the G Corp. securities constructively distributed to Z is equal to 
the $20,000 adjusted tax basis of LK's partnership interest before the 
constructive liquidation. Under paragraph (b)(1)(iv) of Sec. 1.708-1, 
the partners then are treated as contributing to a new partnership the 
property constructively distributed to them in connection with the 
partnership's termination. In accordance with paragraph (b)(2)(iv)(d) of 
this section, the capital accounts of Z and LK in the reconstituted 
partnership are stated at $20,000 each (i.e., the fair market value of 
the property constructively contributed to the new partnership by each 
of the partners).
    Example 14. (i) MC and RW form a general partnership to which each 
contributes $10,000. The $20,000 is invested in securities of Ventureco 
(which are not readily tradable on an established securities market). In 
each of the partnership's taxable years, it recognizes operating income 
equal to its operating deductions (excluding gain or loss from the sale 
of securities). The partnership agreement provides that the partners' 
capital accounts will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, distributions in liquidation of 
the partnership (or any partner's interest) will be made in accordance 
with the partners' positive capital account balances, and any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraphs (b)(2)(ii)(b)(2) and (3) of this section). The 
partnership uses the interim closing of the books method for purposes of 
section 706. Assume that the Ventureco securities subsequently 
appreciate in value to $50,000. At that time SK makes a $25,000 cash 
contribution to the partnership (thereby acquiring a one-third interest 
in the partnership), and the $25,000 is placed in a bank account. Upon 
SK's admission to the partnership, the capital accounts of MC and RW 
(which were $10,000 each prior to SK's admission) are, in accordance 
with paragraph (b)(2)(iv)(f) of

[[Page 328]]

this section, adjusted upward (to $25,000 each) to reflect their shares 
of the unrealized appreciation in the Ventureco securities that occurred 
before SK was admitted to the partnership. Immediately after SK's 
admission to the partnership, the securities are sold for their $50,000 
fair market value, resulting in taxable gain of $30,000 ($50,000 less 
$20,000 adjusted tax basis) and no book gain or loss. An allocation of 
the $30,000 taxable gain cannot have economic effect since it cannot 
properly be reflected in the partners' book capital accounts. Under 
paragraph (b)(2)(iv)(f) of this section and the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, unless the partnership agreement provides that the $30,000 
taxable gain will, in accordance with section 704(c) principles, be 
shared $15,000 to MC and $15,000 to RW, the partners' capital accounts 
will not be considered maintained in accordance with paragraph 
(b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                         MC                    RW                    SK         
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission......    $10,000    $25,000    $10,000    $25,000    $25,000    $25,000
Plus: gain....................................     15,000          0     15,000          0          0          0
                                               -----------------------------------------------------------------
Capital account following sale................    $25,000    $25,000    $25,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------

    (ii) Assume the same facts as (i), except that after SK's admission 
to the partnership, the Ventureco securities appreciate in value to 
$74,000 and are sold, resulting in taxable gain of $54,000 ($74,000 less 
$20,000 adjusted tax basis) and book gain of $24,000 ($74,000 less 
$50,000 book value). Under the partnership agreement the $24,000 book 
gain (the appreciation in value occurring after SK became a partner) is 
allocated equally among MC, RW, and SK, and such allocations have 
substantial economic effect. An allocation of the $54,000 taxable gain 
cannot have economic effect since it cannot properly be reflected in the 
partners' book capital accounts. Under paragraph (b)(2)(iv)(f) of this 
section and the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, unless the partnership 
agreement provides that the taxable gain will, in accordance with 
section 704(c) principles, be shared $23,000 to MC $23,000 to RW, and 
$8,000 to SK, the partners' capital accounts will not be considered 
maintained in accordance with paragraph (b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                         MC                    RW                    SK         
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission......    $10,000    $25,000    $10,000    $25,000    $25,000    $25,000
Plus: gain....................................     23,000      8,000     23,000      8,000      8,000      8,000
                                               -----------------------------------------------------------------
      Capital account following sale..........    $33,000    $33,000    $33,000    $33,000    $33,000    $33,000
----------------------------------------------------------------------------------------------------------------

    (iii) Assume the same facts as (i) except that after SK's admission 
to the partnership, the Ventureco securities depreciate in value to 
$44,000 and are sold, resulting in taxable gain of $24,000 ($44,000 less 
$20,000 adjusted tax basis) and a book loss of $6,000 ($50,000 book 
value less $44,000). Under the partnership agreement the $6,000 book 
loss is allocated equally among MC, RW, and SK, and such allocations 
have substantial economic effect. An allocation of the $24,000 taxable 
gain cannot have economic effect since it cannot properly be reflected 
in the partners' book capital accounts. Under paragraph (b)(2)(iv)(f) of 
this section and the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, unless the partnership 
agreement provides that the $24,000 taxable gain will, in accordance 
with section 704(c) principles, be shared equally between MC and RW, the 
partners' capital accounts will not be considered maintained in 
accordance with paragraph (b)(2)(iv) of this section.

----------------------------------------------------------------------------------------------------------------
                                                       MC                     RW                     SK         
                                            --------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account following SK's admission...    $10,000    $25,000     $10,000    $25,000     $25,000    $25,000 
Plus: gain.................................     12,000          0      12,000          0           0          0 
Less: loss.................................          0     (2,000)          0     (2,000)          0     (2,000)
                                            --------------------------------------------------------------------
      Capital account following sale.......    $22,000    $23,000     $22,000    $23,000     $25,000    $25,000 
----------------------------------------------------------------------------------------------------------------


[[Page 329]]

That SK bears an economic loss of $2,000 without a corresponding taxable 
loss is attributable entirely to the ``ceiling rule.'' See paragraph 
(c)(2) of Sec. 1.704-1.
    (iv) Assume the same facts as in (ii) except that upon the admission 
of SK the capital accounts of MC and RW are not each adjusted upward 
from $10,000 to $25,000 to reflect the appreciation in the partnership's 
securities that occurred before SK was admitted to the partnership. 
Rather, upon SK's admission to the partnership, the partnership 
agreement is amended to provide that the first $30,000 of taxable gain 
upon the sale of such securities will be allocated equally between MC 
and RW, and that all other income, gain, loss, and deduction will be 
allocated equally between MC, RW, and SK. When the securities are sold 
for $74,000, the $54,000 of taxable gain is so allocated. These 
allocations of taxable gain have substantial economic effect. (If the 
agreement instead provides for all taxable gain (including the $30,000 
taxable gain attributable to the appreciation in the securities prior to 
SK's admission to the partnership) to be allocated equally between MC, 
RW, and SK, the partners should consider whether, and to what extent, 
the provisions of paragraphs (b)(1) (iii) and (iv) of this section are 
applicable.)
    (v) Assume the same facts as in (iv) except that instead of selling 
the securities, the partnership makes a distribution of the securities 
(which have a fair market value of $74,000). Assume the distribution 
does not give rise to a transaction described in section 707(a)(2)(B). 
In accordance with paragraph (b)(2)(iv)(e) of this section, the 
partners' capital accounts are adjusted immediately prior to the 
distribution to reflect how taxable gain ($54,000) would have been 
allocated had the securities been sold for their $74,000 fair market 
value, and capital account adjustments in respect of the distribution of 
the securities are made with reference to the $74,000 ``booked-up'' fair 
market value.

------------------------------------------------------------------------
                                             MC         RW         SK   
------------------------------------------------------------------------
Capital account before adjustment......   $10,000    $10,000    $25,000 
Deemed sale adjustment.................    23,000     23,000      8,000 
Less: distribution.....................   (24,667)   (24,667)   (24,667)
                                        --------------------------------
      Capital account after                                             
       distribution....................    $8,333     $8,333     $8,333 
------------------------------------------------------------------------

    (vi) Assume the same facts as in (i) except that the partnership 
does not sell the Ventureco securities. During the next 3 years the fair 
market value of the Ventureco securities remains at $50,000, and the 
partnership engages in no other investment activities. Thus, at the end 
of that period the balance sheet of the partnership and the partners' 
capital accounts are the same as they were at the beginning of such 
period. At the end of the 3 years, MC's interest in the partnership is 
liquidated for the $25,000 cash held by the partnership. Assume the 
distribution does not give rise to a transaction described in section 
707(a)(2)(B). Assume further that the partnership has a section 754 
election in effect for the taxable year during which such liquidation 
occurs. Under sections 734(b) and 755 the partnership increases the 
basis of the Ventureco securities by the $15,000 basis adjustment (the 
excess of $25,000 over the $10,000 adjusted tax basis of MC's 
partnership interest).

----------------------------------------------------------------------------------------------------------------
                                                        MC                     RW                    SK         
                                             -------------------------------------------------------------------
                                                  Tax        Book        Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account before distribution.........    $10,000     $25,000     $10,000    $25,000    $25,000    $25,000
Plus: basis adjustment......................     15,000           0           0          0          0          0
Less: distribution..........................    (25,000)    (25,000)          0          0          0          0
                                             -------------------------------------------------------------------
Capital account account after liquidation...          0           0     $10,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------

    (vii) Assume the same facts as in (vi) except that the partnership 
has no section 754 election in effect for the taxable year during which 
such liquidation occurs.

----------------------------------------------------------------------------------------------------------------
                                                        MC                     RW                    SK         
                                             -------------------------------------------------------------------
                                                  Tax        Book        Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account before distribution.........    $10,000     $25,000     $10,000    $25,000    $25,000    $25,000
Less: distribution..........................    (25,000)    (25,000)          0          0          0          0
                                             -------------------------------------------------------------------
Capital account after liquidation...........   ($15,000)          0     $10,000    $25,000    $25,000    $25,000
----------------------------------------------------------------------------------------------------------------


[[Page 330]]

Following the liquidation of MC's interest in the partnership, the 
Ventureco securities are sold for their $50,000 fair market value, 
resulting in no book gain or loss but a $30,000 taxable gain. An 
allocation of this $30,000 taxable gain cannot have economic effect 
since it cannot properly be reflected in the partners' book capital 
accounts. Under paragraph (b)(2)(iv)(f) of this section and the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, unless the partnership agreement provides 
that $15,000 of such taxable gain will, in accordance with section 
704(c) principles, be included in RW's distributive share, the partners' 
capital accounts will not be considered maintained in accordance with 
paragraph (b)(2)(iv) of this section. The remaining $15,000 of such gain 
will, under paragraph (b)(3) of this section, be shared equally between 
RW and SK.
    Example 15. (i) JB and DK form a limited partnership for the purpose 
of purchasing residential real estate to lease. JB, the limited partner, 
contributes $13,500, and DK, the general partner, contributes $1,500. 
The partnership, which uses the cash receipts and disbursements method 
of accounting, purchases a building for $100,000 (on leased land), 
incurring a recourse mortgage of $85,000 that requires the payment of 
interest only for a period of 3 years. The partnership agreement 
provides that partnership net taxable income and loss will be allocated 
90 percent to JB and 10 percent to DK, the partners' capital accounts 
will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances (as set forth in 
paragraph (b)(2)(ii)(b)(2) of this section), and JB is not required to 
restore any deficit balance in his capital account, but DK is so 
required. The partnership agreement contains a qualified income offset 
(as defined in paragraph (b)(2)(ii)(d) of this section). As of the end 
of each of the partnership's first 3 taxable years, the items described 
in paragraphs (b)(2)(ii)(d)(4), (5), and (6) of this section are not 
reasonably expected to cause or increase a deficit balance in JB's 
capital account. In the partnership's first taxable year, it has rental 
income of $10,000, operating expenses of $2,000, interest expense of 
$8,000, and cost recovery deductions of $12,000. Under the partnership 
agreement JB and DK are allocated $10,800 and $1,200, respectively, of 
the $12,000 net taxable loss incurred in the partnership's first taxable 
year.

------------------------------------------------------------------------
                                                        JB         DK   
------------------------------------------------------------------------
Capital account upon formation....................   $13,500     $1,500 
Less: year 1 net loss.............................   (10,800)    (1,200)
                                                   ---------------------
Capital account at end of year 1..................    $2,700       $300 
------------------------------------------------------------------------

The alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section is satisfied as of the end of the partnership's first 
taxable year. Thus, the allocation made in the partnership's first 
taxable year has economic effect.
    (ii) Assume the same facts as in (i) and that in the partnership's 
second taxable year it again has rental income of $10,000, operating 
expenses of $2,000, interest expense of $8,000, and cost recovery 
deductions of $12,000. Under the partnership agreement JB and DK are 
allocated $10,800 and $1,200, respectively, of the $12,000 net taxable 
loss incurred in the partnership's second taxable year.

------------------------------------------------------------------------
                                                        JB         DK   
------------------------------------------------------------------------
Capital account at beginning of year 1............    $2,700       $300 
Less: year 2 net loss.............................   (10,800)    (1,200)
                                                   ---------------------
      Capital account at end of year 2............   ($8,100)     ($900)
------------------------------------------------------------------------


[[Page 331]]

Only $2,700 of the $10,800 net taxable loss allocated to JB satisfies 
the alternate economic effect test contained in paragraph (b)(2)(ii)(d) 
of this section as of the end of the partnership's second taxable year. 
The allocation of such $2,700 net taxable loss to JB (consisting of 
$2,250 of rental income, $450 of operating expenses, $1,800 of interest 
expense, and $2,700 of cost recovery deductions) has economic effect. 
The remaining $8,100 of net taxable loss allocated by the partnership 
agreement to JB must be reallocated in accordance with the partners' 
interests in the partnership. Under paragraph (b)(3)(iii) of this 
section, the determination of the partners' interests in the remaining 
$8,100 net taxable loss is made by comparing how distributions (and 
contributions) would be made if the partnership sold its property at its 
adjusted tax basis and liquidated immediately following the end of the 
partnership's first taxable year with the results of such a sale and 
liquidation immediately following the end of the partnership's second 
taxable year. If the partnership's real property were sold for its 
$88,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's first taxable year, 
the $88,000 sales proceeds would be used to repay the $85,000 note, and 
there would be $3,000 remaining in the partnership, which would be used 
to make liquidating distributions to DK and JB of $300 and $2,700, 
respectively. If such property were sold for its $76,000 adjusted tax 
basis and the partnership were liquidated immediately following the end 
of the partnership's second taxable year, DK would be required to 
contribute $9,000 to the partnership in order for the partnership to 
repay the $85,000 note, and there would be no assets remaining in the 
partnership to distribute. A comparison of these outcomes indicates that 
JB bore $2,700 and DK $9,300 of the economic burden that corresponds to 
the $12,000 net taxable loss. Thus, in addition to the $1,200 net 
taxable loss allocated to DK under the partnership agreement, $8,100 of 
net taxable loss will be reallocated to DK under paragraph (b)(3)(iii) 
of this section. Similarly, for subsequent taxable years, absent an 
increase in JB's capital account, all net taxable loss allocated to JB 
under the partnership agreement will be reallocated to DK.
    (iii) Assume the same facts as in (ii) and that in the partnership's 
third taxable year there is rental income of $35,000, operating expenses 
of $2,000, interest expense of $8,000, and cost recovery deductions of 
$10,000. The capital accounts of the partners maintained on the books of 
the partnership do not take into account the reallocation to DK of the 
$8,100 net taxable loss in the partnership's second taxable year. Thus, 
an allocation of the $15,000 net taxable income $13,500 to JB and $1,500 
to DK (as dictated by the partnership agreement and as reflected in the 
capital accounts of the partners) does not have economic effect. The 
partners' interests in the partnership with respect to such $15,000 
taxable gain again is made in the manner described in paragraph (b) (3) 
(iii) of this section. If the partnership's real property were sold for 
its $76,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's second taxable year, 
DK would be required to contribute $9,000 to the partnership in order 
for the partnership to repay the $85,000 note, and there would be no 
assets remaining to distribute. If such property were sold for its 
$66,000 adjusted tax basis and the partnership were liquidated 
immediately following the end of the partnership's third taxable year, 
the $91,000 ($66,000 sales proceeds plus $25,000 cash on hand) would be 
used to repay the $85,000 note and there would be $6,000 remaining in 
the partnership, which would be used to make liquidating distributions 
to DK and JB of $600 and $5,400, respectively. Accordingly, under 
paragraph (b) (3) (iii) of this section the $15,000 net taxable income 
in the partnership's third taxable year will be reallocated $9,600 to DK 
(minus $9,000 at end of the second taxable year to positive $600 at end 
of the third taxable year) and $5,400 to JB (zero at end of the second 
taxable year to positive $5,400 at end of the third taxable year).
    Example 16. (i) KG and WN form a limited partnership for the purpose 
of investing in improved real estate. KG, the general partner, 
contributes $10,000 to the partnership, and WN, the limited partner, 
contributes $990,000 to the partnership. The $1,000,000 is used to 
purchase an apartment building on leased land. The partnership agreement 
provides that (1) the partners' capital accounts will be determined and 
maintained in accordance with paragraph (b)(2)(iv) of this section; (2) 
cash will be distributed first to WN until such time as he has received 
the amount of his original capital contribution ($990,000), next to KG 
until such time as he has received the amount of his original capital 
contribution ($10,000), and thereafter equally between WN and KG; (3) 
partnership net taxable income will be allocated 99 percent to WN and 1 
percent to KG until the cumulative net taxable income allocated for all 
taxable years is equal to the cumulative net taxable loss previously 
allocated to the partners, and thereafter equally between WN and KG; (4) 
partnership net taxable loss will be allocated 99 percent to WN and 1 
percent to KG, unless net taxable income has previously been allocated 
equally between WN and KG, in which case such net taxable loss first 
will be allocated equally until the cumulative net taxable loss 
allocated for all taxable years is equal to the cumulative net taxable 
income previously allocated to the partners; and (5) upon liquidation, 
WN is not required to restore any deficit balance in his

[[Page 332]]

capital account, but KG is so required. Since distributions in 
liquidation are not required to be made in accordance with the partners' 
positive capital account balances, and since WN is not required, upon 
the liquidation of his interest, to restore the deficit balance in his 
capital account to the partnership, the allocations provided by the 
partnership agreement do not have economic effect and will be 
reallocated in accordance with the partners' interests in the 
partnership under paragraph (b) (3) of this section.
    (ii) Assume the same facts as in (i) except that the partnership 
agreement further provides that distributions in liquidation of the 
partnership (or any partner's interest) are to be made in accordance 
with the partners' positive capital account balances (as set forth in 
paragraph (b)(2)(ii)(b)(2) of this section). Assume further that the 
partnership agreement contains a qualified income offset (as defined in 
paragraph (b)(2)(ii)(d) of this section) and that, as of the end of each 
partnership taxable year, the items described in paragraphs 
(b)(2)(iii)(d) (4), (5), and (6) of this section are not reasonably 
expected to cause or increase a deficit balance in WN's capital account. 
The allocations provided by the partnership agreement have economic 
effect.
    Example 17. FG and RP form a partnership with FG contributing cash 
of $100 and RP contributing property, with 2 years of cost recovery 
deductions remaining, that has an adjusted tax basis of $80 and a fair 
market value of $100. The partnership, FG, and RP have calendar taxable 
years. The partnership agreement provides that the partners' capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, liquidation proceeds will be made in 
accordance with capital account balances, and each partner is liable to 
restore the deficit balance in his capital account to the partnership 
upon liquidation of his interest (as set forth in paragraphs 
(b)(2)(ii)(b) (2) and (3) of this section). FG expects to be in a 
substantially higher tax bracket than RP in the partnership's first 
taxable year. In the partnership's second taxable year, and in 
subsequent taxable years, it is expected that both will be in 
approximately equivalent tax brackets. The partnership agreement 
allocates all items equally except that all $50 of book depreciation is 
allocated to FG in the partnership's first taxable year and all $50 of 
book depreciation is allocated to RP in the partnership's second taxable 
year. If the allocation to FG of all book depreciation in the 
partnership's first taxable year is respected, FG would be entitled 
under section 704(c) to the entire cost recovery deduction ($40) for 
such year. Likewise, if the allocation to RP of all the book 
depreciation in the partnership's second taxable year is respected, RP 
would be entitled under section 704(c) to the entire cost recovery 
deduction ($40) for such year. The allocation of book depreciation to FG 
and RP in the partnership's first 2 taxable years has economic effect 
within the meaning of paragraph (b)(2)(ii) of this section. However, the 
economic effect of these allocations is not substantial under the test 
described in paragraph (b)(2)(iii)(c) of this section since there is a 
strong likelihood at the time such allocations became part of the 
partnership agreement that at the end of the 2-year period to which such 
allocations relate, the net increases and decreases to FG's and RP's 
capital accounts will be the same with such allocations as they would 
have been in the absence of such allocation, and the total tax liability 
of FG and RP for the taxable years to which the section 704(c) 
determinations relate would be reduced as a result of the allocations of 
book depreciation. As a result the allocations of book depreciation in 
the partnership agreement will be disregarded. FG and RP will be 
allocated such book depreciation in accordance with the partners' 
interests in the partnership under paragraph (b)(3) of this section. 
Under these facts the book depreciation deductions will be reallocated 
equally between the partners, and section 704(c) will be applied with 
reference to such reallocation of book depreciation.
    Example 18. (i) WM and JL form a general partnership by each 
contributing $300,000 thereto. The partnership uses the $600,000 to 
purchase an item of tangible personal property, which it leases out. The 
partnership elects under section 48 (q)(4) to reduce the amount of 
investment tax credit in lieu of adjusting the tax basis of such 
property. The partnership agreement provides that (1) the partners' 
capital account will be determined and maintained in accordance with 
paragraph (b)(2)(iv) of this section, (2) distributions in liquidation 
of the partnership (or any partner's interest) will be made in 
accordance with the partners' positive capital account balances (as set 
forth in paragraph (b)(2)(ii)(b)(2) of this section), (3) any partner 
with a deficit balance in his capital account following the liquidation 
of his interest must restore that deficit to the partnership (as set 
forth in paragraph (b)(2)(ii)(b)(3) of this section), (4) all income, 
gain, loss, and deduction of the partnership will be allocated equally 
between the partners, and (5) all non-liquidating distributions of the 
partnership will be made equally between the partners. Assume that in 
each of the partnership's taxable years, it recognizes operating income 
equal to its operating deductions (excluding cost recovery and 
depreciation deductions and gain or loss on the sale of its property). 
During its first 2 taxable years, the partnership has an additional 
$200,000 cost recovery deduction in each year. Pursuant to the 
partnership agreement these items are allocated equally between WM and 
JL.

[[Page 333]]



------------------------------------------------------------------------
                                                      WM          JL    
------------------------------------------------------------------------
Capital account upon formation..................   $300,000    $300,000 
Less: Net loss for years 1 and 2................  (200,000)   (200,000) 
                                                 -----------------------
      Capital account at end of year 2..........   $100,000    $100,000 
------------------------------------------------------------------------

The allocations made in the partnership's first 2 taxable years have 
substantial economic effect.
    (ii) Assume the same facts as in (i) and that MK is admitted to the 
partnership at the beginning of the partnership's third taxable year. At 
the time of his admission, the fair market value of the partnership 
property is $600,000. MK contributes $300,000 to the partnership in 
exchange for an equal one-third interest in the partnership, and, as 
permitted under paragraph (b)(2)(iv)(g), the capital accounts of WM and 
JL are adjusted upward to $300,000 each to reflect the fair market value 
of partnership property. In addition, the partnership agreement is 
modified to provide that depreciation and gain or loss, as computed for 
tax purposes, with respect to the partnership property that appreciated 
prior to MK's admission will be shared among the partners in a manner 
that takes account of the variation between such property's $200,000 
adjusted tax basis and its $600,000 book value in accordance with 
paragraph (b)(2)(iv)(f) and the special rule contained in paragraph 
(b)(4)(i) of this section. Depreciation and gain or loss, as computed 
for book purposes, with respect to such property will be allocated 
equally among the partners and, in accordance with paragraph 
(b)(2)(iv)(g) of this section, will be reflected in the partner's 
capital accounts, as will all other partnership income, gain, loss, and 
deduction. Since the requirements of (b)(2)(iv)(g) of this section are 
satisfied, the capital accounts of the partners (as adjusted) continue 
to be maintained in accordance with paragraph (B)(2)(iv) of this 
section.
    (iii) Assume the same facts as in (ii) and that immediately after 
MK's admission to the partnership, the partnership property is sold for 
$600,000, resulting in a taxable gain of $400,000 ($600,000 less 
$200,000 adjusted tax basis) and no book gain or loss, and the 
partnership is liquidated. An allocation of the $400,000 taxable gain 
cannot have economic effect because such gain cannot properly be 
reflected in the partners' book capital accounts. Consistent with the 
special partners' interests in the partnership rule contained in 
paragraph (b)(4)(i) of this section, the partnership agreement provides 
that the $400,000 taxable gain will, in accordance with section 704(c) 
principles, be shared equally between WM and JL.

----------------------------------------------------------------------------------------------------------------
                                                         WM                    JL                    MK         
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3........   $100,000   $300,000   $100,000   $300,000   $300,000   $300,000
Plus: gain....................................    200,000          0    200,000          0          0          0
                                               -----------------------------------------------------------------
      Capital account before liquidation......   $300,000   $300,000   $300,000   $300,000   $300,000   $300,000
----------------------------------------------------------------------------------------------------------------

The $900,000 of partnership cash ($600,000 sales proceeds plus $300,000 
contributed by MK) is distributed equally among WM, JL, and MK in 
accordance with their adjusted positive capital account balances, each 
of which is $300,000.
    (iv) Assume the same facts as in (iii) except that prior to 
liquidation the property appreciates and is sold for $900,000, resulting 
in a taxable gain of $700,000 ($900,000 less $200,000 adjusted tax 
basis) and a book gain of $300,000 ($900,000 less $600,000 book value). 
Under the partnership agreement the $300,000 of book gain is allocated 
equally among the partners, and such allocation has substantial economic 
effect.

----------------------------------------------------------------------------------------------------------------
                                                         WM                    JL                    MK         
                                               -----------------------------------------------------------------
                                                   Tax        Book       Tax        Book       Tax        Book  
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3........   $100,000   $300,000   $100,000   $300,000   $300,000   $300,000
Plus: gain....................................    300,000    100,000    300,000    100,000    100,000    100,000
                                               -----------------------------------------------------------------
      Capital account before liquidation......   $400,000   $400,000   $400,000   $400,000   $400,000   $400,000
----------------------------------------------------------------------------------------------------------------


[[Page 334]]

Consistent with the special partners' interests in the partnership rule 
contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $700,000 taxable gain is, in accordance with 
section 704(c) principles, shared $300,000 to JL, $300,000 to WM, and 
$100,000 to MK. This ensures that (1) WM and JL share equally the 
$400,000 taxable gain that is attributable to appreciation in the 
property that occurred prior to MK's admission to the partnership in the 
same manner as it was reflected in their capital accounts upon MK's 
admission, and (2) WM, JL, and MK share equally the additional $300,000 
taxable gain in the same manner as they shared the $300,000 book gain.
    (v) Assume the same facts as in (ii) except that shortly after MK's 
admission the property depreciates and is sold for $450,000, resulting 
in a taxable gain of $250,000 ($450,000 less $200,000 adjusted tax 
basis) and a book loss of $150,000 (450,000 less $600,000 book value). 
Under the partnership agreement these items are allocated as follow:

----------------------------------------------------------------------------------------------------------------
                                                       WM                     JL                     MK         
                                            --------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3.....   $100,000   $300,000    $100,000   $300,000    $300,000   $300,000 
Plus: gain.................................    125,000          0     125,000          0           0          0 
Less: loss.................................          0    (50,000)          0    (50,000)          0    (50,000)
                                            --------------------------------------------------------------------
      Capital account before liquidation...   $225,000   $250,000    $225,000   $250,000    $300,000   $250,000 
----------------------------------------------------------------------------------------------------------------

The $150,000 book loss is allocated equally among the partners, and such 
allocation has substantial economic effect. Consistent with the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, the partnership agreement provides that the 
$250,000 taxable gain is, in accordance with section 704(c) principles, 
shared equally between WM and JL. The fact that MK bears an economic 
loss of $50,000 without a corresponding taxable loss is attributable 
entirely to the ``ceiling rule.'' See paragraph (c)(2) of Sec. 1.704-1.
    (vi) Assume the same facts as in (ii) except that the property 
depreciates and is sold for $170,000, resulting in a $30,000 taxable 
loss ($200,000 adjusted tax basis less $170,000) and a book loss of 
$430,000 ($600,000 book value less $170,000). The book loss of $430,000 
is allocated equally among the partners ($143,333 each) and has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the entire $30,000 
taxable loss is, in accordance with section 704(c) principles, included 
in MK's distributive share.

----------------------------------------------------------------------------------------------------------------
                                                      WM                     JL                     MK          
                                           ---------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3....   $100,000   $300,000    $100,000   $300,000    $300,000    $300,000 
Less Loss.................................          0   (143,333)          0   (143,333)    (30,000)   (143,333)
                                           ---------------------------------------------------------------------
Capital account before liquidation........   $100,000   $156,667    $100,000   $156,667    $270,000    $156,667 
----------------------------------------------------------------------------------------------------------------

    (vii) Assume the same facts as in (ii) and that during the 
partnership's third taxable year, the partnership has an additional 
$100,000 cost recovery deduction and $300,000 book depreciation 
deduction attributable to the property purchased by the partnership in 
its first taxable year. The $300,000 book depreciation deduction is 
allocated equally among the partners, and that allocation has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the $100,000 cost 
recovery deduction for the partnership's third taxable year is, in 
accordance with section 704(c) principles, included in MK's distributive 
share. This is because under these facts those principles require MK to 
include the cost recovery deduction for such property in his 
distributive share up to the amount of the book depreciation deduction 
for such property properly allocated to him.

[[Page 335]]



----------------------------------------------------------------------------------------------------------------
                                                      WM                     JL                     MK          
                                           ---------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3....   $100,000   $300,000    $100,000   $300,000    $300,000    $300,000 
Less: recovery/depreciation deduction for                                                                       
 year 3...................................          0   (100,000)          0   (100,000)   (100,000)   (100,000)
                                           ---------------------------------------------------------------------
Capital account at end of year 3..........   $100,000   $200,000    $100,000   $200,000    $200,000    $200,000 
----------------------------------------------------------------------------------------------------------------

    (viii) Assume the same facts as in (vii) except that upon MK's 
admission the partnership property has an adjusted tax basis of $220,000 
(instead of $200,000), and thus the cost recovery deduction for the 
partnership's third taxable year is $110,000. Assume further that upon 
MK's admission WM and JL have adjusted capital account balances of 
$110,000 and $100,000, respectively. Consistent with the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, the partnership agreement provides that the 
excess $10,000 cost recovery deduction ($110,000 less $100,000 included 
in MK's distributive share) is, in accordance with section 704 (c) 
principles, shared equally between WM and JL and is so included in their 
respective distributive shares for the partnership's third taxable year.
    (ix) Assume the same facts as in (vii) except that upon MK's 
admission the partnership agreement is amended to allocate the first 
$400,000 of book depreciation and loss on partnership property equally 
between WM and JL and the last $200,000 of such book depreciation and 
loss to MK. Assume such allocations have substantial economic effect. 
Pursuant to this amendment the $300,000 book depreciation deduction in 
the partnership's third taxable year is allocated equally between WM and 
JL. Consistent with the special partners' interests in the partnership 
rule contained in paragraph (b)(4)(i) of this section, the partnership 
agreement provides that the $100,000 cost recovery deduction is, in 
accordance with section 704(c) principles, shared equally between WM and 
JL. In the partnership's fourth taxable year, it has a $60,000 cost 
recovery deduction and a $180,000 book depreciation deduction. Under the 
amendment described above, the $180,000 book depreciation deduction is 
allocated $50,000 to WM, $50,000 to JL, and $80,000 to MK. Consistent 
with the special partners' interests in the partnership rule contained 
in paragraph (b)(4)(i) of this section, the partnership agreement 
provides that the $60,000 cost recovery deduction is, in accordance with 
section 704(c) principles, included entirely in MK's distributive share.

----------------------------------------------------------------------------------------------------------------
                                                    WM                      JL                      MK          
                                         -----------------------------------------------------------------------
                                              Tax        Book         Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3..   $100,000    $300,000    $100,000    $300,000    $300,000    $300,000 
Less:                                                                                                           
    (a) recovery/depreciation deduction                                                                         
     for year 3.........................    (50,000)   (150,000)    (50,000)   (150,000)          0           0 
    (b) recovery/depreciation deduction                                                                         
     for year 4.........................          0     (50,000)          0     (50,000)    (60,000)    (80,000)
                                         -----------------------------------------------------------------------
      Capital account at end of year 4..    $50,000    $100,000     $50,000    $100,000    $240,000    $220,000 
----------------------------------------------------------------------------------------------------------------


[[Page 336]]

    (x) Assume the same facts as in (vii) and that at the beginning of 
the partnership's third taxable year, the partnership purchases a second 
item of tangible personal property for $300,000 and elects under section 
48(q) (4) to reduce the amount of investment tax credit in lieu of 
adjusting the tax basis of such property. The partnership agreement is 
amended to allocate the first $150,000 of cost recovery deductions and 
loss from such property to WM and the next $150,000 of cost recovery 
deductions and loss from such property equally between JL and MK. Thus, 
in the partnership's third taxable year it has, in addition to the items 
specified in (vii), a cost recovery and book depreciation deduction of 
$100,000 attributable to the newly acquired property, which is allocated 
entirely to WM.
As in (vii), the allocation of the $300,000 book depreciation 
attributable to the property purchased in the partnership's first 
taxable year equally among the partners has substantial economic effect, 
and consistent with the special partners' interests in the partnership 
rule contained in paragraph (b)(4)(i) of this section, the partnership 
agreement properly provides for the entire $100,000 cost recovery 
deduction attributable to such property to be included in MK's 
distributive share. Furthermore, the allocation to WM of the $100,000 
cost recovery deduction attributable to the property purchased in the 
partnership's third taxable year has substantial economic effect.

----------------------------------------------------------------------------------------------------------------
                                                     WM                      JL                     MK          
                                          ----------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 3...   $100,000    $300,000    $100,000   $300,000    $300,000    $300,000 
Less:                                                                                                           
    (a) recovery/depreciation deduction                                                                         
     for property bought in year 1.......          0    (100,000)          0   (100,000)   (100,000)   (100,000)
    (b) recovery/depreciation deduction                                                                         
     for property bought in year 3.......   (100,000)   (100,000)          0          0           0           0 
                                          ----------------------------------------------------------------------
      Capital account at end of year 3...          0    $100,000    $100,000   $200,000    $200,000    $200,000 
----------------------------------------------------------------------------------------------------------------

    (xi) Assume the same facts as in (x) and that at the beginning of 
the partnership's fourth taxable year, the properties purchased in the 
partnership's first and third taxable years are disposed of for $90,000 
and $180,000, respectively, and the partnership is liquidated. With 
respect to the property purchased in the first taxable year, there is a 
book loss of $210,000 ($300,000 book value less $90,000) and a taxable 
loss of $10,000 ($100,000 adjusted tax basis less $90,000). The book 
loss is allocated equally among the partners, and such allocation has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in paragraph (b)(4)(i) of 
this section, the partnership agreement provides that the taxable loss 
of $10,000 will, in accordance with section 704(c) principles, be 
included entirely in MK's distributive share. With respect to the 
property purchased in the partnership's third taxable year, there is a 
book and taxable loss of $20,000. Pursuant to the partnership agreement 
this loss is allocated entirely to WM, and such allocation has 
substantial economic effect.

----------------------------------------------------------------------------------------------------------------
                                                     WM                      JL                     MK          
                                          ----------------------------------------------------------------------
                                               Tax        Book        Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 4...          0    $100,000    $100,000   $200,000    $200,000    $200,000 
Less:                                                                                                           
    (a) loss on property bought in year 1          0     (70,000)          0    (70,000)    (10,000)    (70,000)
    (b) loss on property bought in year 3    (20,000)    (20,000)          0          0           0           0 
                                          ----------------------------------------------------------------------
      Capital account before liquidation.   ($20,000)    $10,000    $100,000   $130,000    $190,000    $130,000 
----------------------------------------------------------------------------------------------------------------

Partnership liquidation proceeds ($270,000) are properly distributed in 
accordance with the partners' adjusted positive book capital account 
balances ($10,000 to WM, $130,000 to JL and $130,000 to MK).
    (xii) Assume the same facts as in (x) and that in the partnership's 
fourth taxable year it has a cost recovery deduction of $60,000 and book 
depreciation deduction of $180,000 attributable to the property 
purchased in the partnership's first taxable year, and a cost recovery 
and book depreciation deduction of $100,000 attributable to the property 
purchased in the partnership's third taxable year. The $180,000 book 
depreciation deduction attributable to the property purchased in the 
partnership's first taxable year is allocated equally among the 
partners, and such

[[Page 337]]

allocation has substantial economic effect. Consistent with the special 
partners' interests in the partnership rule contained in paragraph 
(b)(4)(i) of this section, the partnership agreement provides that the 
$60,000 cost recovery deduction attributable to the property purchased 
in the first taxable year is, in accordance with section 704(c) 
principles, included entirely in MK's distributive share. Furthermore, 
the $100,000 cost recovery deduction attributable to the property 
purchased in the third taxable year is allocated $50,000 to WM, $25,000 
to JL, and $25,000 to MK, and such allocation has substantial economic 
effect.

----------------------------------------------------------------------------------------------------------------
                                                    WM                      JL                      MK          
                                         -----------------------------------------------------------------------
                                              Tax        Book         Tax        Book         Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 4..          0    $100,000    $100,000    $200,000    $200,000    $200,000 
Less:                                                                                                           
    (a) recovery/depreciation deduction                                                                         
     for property bought in year 1......          0     (60,000)          0     (60,000)    (60,000)    (60,000)
    (b) recovery/depreciation deduction                                                                         
     for property bought in year 3......    (50,000)    (50,000)    (25,000)    (25,000)    (25,000)    (25,000)
                                         -----------------------------------------------------------------------
      Capital account at end of year 4..   ($50,000)   ($10,000)    $75,000    $115,000    $115,000    $115,000 
----------------------------------------------------------------------------------------------------------------

At the end of the partnership's fourth taxable year the adjusted tax 
bases of the partnership properties acquired in its first and third 
taxable years are $40,000 and $100,000, respectively. If the properties 
are disposed of at the beginning of the partnership's fifth 
taxable year for their adjusted tax bases, there would be no taxable 
gain or loss, a book loss of $80,000 on the property purchased in the 
partnership's first taxable year ($120,000 book value less $40,000), and 
cash available for distribution of $140,000.

----------------------------------------------------------------------------------------------------------------
                                                      WM                      JL                     MK         
                                           ---------------------------------------------------------------------
                                                Tax        Book        Tax        Book        Tax        Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of year 5....   ($50,000)   ($10,000)    $75,000   $115,000    $115,000   $115,000 
Less: loss................................          0     (26,667)          0    (26,667)          0    (26,667)
                                           ---------------------------------------------------------------------
      Capital account before liquidation..   ($50,000)   ($36,667)    $75,000    $88,333    $115,000    $88,333 
----------------------------------------------------------------------------------------------------------------

If the partnership is then liquidated, the $140,000 of cash on hand plus 
the $36,667 balance that WM would be required to contribute to the 
partnership (the deficit balance in his book capital account) would be 
distributed equally between JL and MK in accordance with their adjusted 
positive book capital account balances.
    (xiii) Assume the same facts as in (i). Any tax preferences under 
section 57(a)(12) attributable to the partnership's cost recovery 
deductions in the first 2 taxable years will be taken into account 
equally by WM and JL. If the partnership agreement instead provides that 
the partnership's cost recovery deductions in its first 2 taxable years 
are allocated 25 percent to WM and 75 percent to JL (and such 
allocations have substantial economic effect), the tax preferences 
attributable to such cost recovery deductions would be taken into 
account 25 percent by WM and 75 percent by JL. The conclusion in the 
previous sentence is unchanged even if the partnership's operating 
expenses (exclusive of cost recovery and depreciation deductions) exceed 
its operating income in each of the partnership's first 2 taxable years, 
the resulting net loss is allocated entirely to WM, and the cost 
recovery deductions are allocated 25 percent to WM and 75 percent to JL 
(provided such allocations have substantial economic effect). If the 
partnership agreement instead provides that all income, gain, loss, and 
deduction (including cost recovery and depreciations) are allocated 
equally between JL and WM, the tax preferences attributable to the cost 
recovery deductions would be taken into account equally by JL and WM. In 
this case, if the partnership has a $100,000 cost recovery deduction in 
its first taxable year and an additional net loss of $100,000 in its 
first taxable year (i.e., its operating expenses exceed its operating 
income by $100,000) and purports to categorize JL's 

[[Page 338]]

$100,000 distributive share of partnership loss as being attributable to 
the cost recovery deduction and WM's $100,000 distributive share of 
partnership loss as being attributable to the net loss, the economic 
effect of such allocations is not substantial, and each partner will be 
allocated one-half of all partnership income, gain, loss, and deduction 
and will take into account one-half of the tax preferences attributable 
to the cost recovery deductions.
    Example 19. (i) DG and JC form a general partnership for the purpose 
of drilling oil wells. DG contributes an oil lease, which has a fair 
market value and adjusted tax basis of $100,000. JC contributes $100,000 
in cash, which is used to finance the drilling operations. The 
partnership agreement provides that DG is credited with a capital 
account of $100,000, and JC is credited with a capital account of 
$100,000. The agreement further provides that the partners' capital 
accounts will be determined and maintained in accordance with paragraph 
(b)(2)(iv) of this section, distributions in liquidation of the 
partnership (or any partner's interest) will be made in accordance with 
the partners' positive capital account balances, and any partner with a 
deficit balance in his capital account following the liquidation of his 
interest must restore such deficit to the partnership (as set forth in 
paragraphs (b)(2)(ii)(b) (2) and (3) of this section. The partnership 
chooses to adjust capital accounts on a simulated cost depletion basis 
and elects under section 48(q)(4) to reduce the amount of investment tax 
credit in lieu of adjusting the basis of its section 38 property. The 
agreement further provides that (1) all additional cash requirements of 
the partnership will be borne equally by DG and JC, (2) the deductions 
attributable to the property (including money) contributed by each 
partner will be allocated to such partner, (3) all other income, gain, 
loss, and deductions (and item thereof) will be allocated equally 
between DG and JC, and (4) all cash from operations will be distributed 
equally between DG and JC. In the partnership's first taxable year 
$80,000 of partnership intangible drilling cost deductions and $20,000 
of cost recovery deductions on partnership equipment are allocated to 
JC, and the $100,000 basis of the lease is, for purposes of the 
depletion allowance under sections 611 and 613A(c)(7)(D), allocated to 
DG. The allocations of income, gain, loss, and deduction provided in the 
partnership agreement have substantial economic effect. Furthermore, 
since the allocation of the entire basis of the lease to DG will not 
result in capital account adjustments (under paragraph (b)(2)(iv)(k) of 
this section) the economic effect of which is insubstantial, and since 
all other partnership allocations are recognized under this paragraph, 
the allocation of the $100,000 adjusted basis of the lease to DG is, 
under paragraph (b)(4)(v) of this section, recognized as being in 
accordance with the partners' interests in partnership capital for 
purposes of section 613A(c)(7)(D).
    (ii) Assume the same facts as in (i) except that the partnership 
agreement provides that (1) all additional cash requirements of the 
partnership for additional expenses will be funded by additional 
contributions from JC, (2) all cash from operations will first be 
distributed to JC until the excess of such cash distributions over the 
amount of such additional expense equals his initial $100,000 
contributions, (3) all deductions attributable to such additional 
operating expenses will be allocated to JC, and (4) all income will be 
allocated to JC until the aggregate amount of income allocated to him 
equals the amount of partnership operating expenses funded by his 
initial $100,000 contribution plus the amount of additional operating 
expenses paid from contributions made solely by him. The allocations of 
income, gain, loss, and deduction provided in partnership agreement have 
economic effect. In addition, the economic effect of the allocations 
provided in the agreement is substantial. Because the partnership's 
drilling activities are sufficiently speculative, there is not a strong 
likelihood at the time the disproportionate allocations of loss and 
deduction to JC are provided for by the partnership agreement that the 
economic effect of such allocations will be largely offset by 
allocations of income. In addition, since the allocation of the entire 
basis of the lease to DG will not result in capital account adjustments 
(under paragraph (b)(2)(iv)(k) of this section) the economic effect of 
which is insubstantial, and since all other partnership allocations are 
recognized under this paragraph, the allocation of the adjusted basis of 
the lease to DG is, under paragraph (b)(4)(v) of this section, 
recognized as being in accordance with the partners' interests in 
partnership capital under section 613A(c)(7)(D).
    (iii) Assume the same facts as in (i) except that all distributions, 
including those made upon liquidation of the partnership, will be made 
equally between DG and JC, and no partner is obligated to restore the 
deficit balance in his capital account to the partnership following the 
liquidation of his interest for distribution to partners with positive 
capital account balances. Since liquidation proceeds will be distributed 
equally between DG and JC irrespective of their capital account 
balances, and since no partner is required to restore the deficit 
balance in his capital account to the partnership upon liquidation (in 
accordance with paragraph (b)(2)(ii)(b)(3) of this section), the 
allocations of income, gain, loss, and deduction provided in the 
partnership agreement do not have economic effect and must be 
reallocated in accordance with the partners' interests in the 
partnership under paragraph (b)(3) of this

[[Page 339]]

section. Under these facts all partnership income, gain, loss, and 
deduction (and item thereof) will be reallocated equally between JC and 
DG. Furthermore, the allocation of the $100,000 adjusted tax basis of 
the lease of DG is not, under paragraph (b)(4)(v) of this section, 
deemed to be in accordance with the partners' interests in partnership 
capital under section 613A(c)(7)(D), and such basis must be reallocated 
in accordance with the partners' interests in partnership capital or 
income as determined under section 613A(c)(7)(D). The results in this 
example would be the same if JC's initial cash contribution were 
$1,000,000 (instead of $100,000), but in such case the partners should 
consider whether, and to what extent, the provisions of paragraph (b)(1) 
of Sec. 1.721-1, and principles related thereto, may be applicable.
    (iv) Assume the same facts as in (i) and that for the partnership's 
first taxable year the simulated depletion deduction with respect to the 
lease is $10,000. Since DG properly was allocated the entire depletable 
basis of the lease (such allocation having been recognized as being in 
accordance with DG's interest in partnership capital with respect to 
such lease), under paragraph (b)(2)(iv)(k)(1) of this section the 
partnership's $10,000 simulated depletion deduction is allocated to DG 
and will reduce his capital account accordingly. If (prior to any 
additional simulated depletion deductions) the lease is sold for 
$100,000, paragraph (b)(4)(v) of this section requires that the first 
$90,000 (i.e., the partnership's simulated adjusted basis in the lease) 
out of the $100,000 amount realized on such sale be allocated to DG (but 
does not directly affect his capital account). The partnership agreement 
allocates the remaining $10,000 amount realized equally between JC and 
DG (but such allocation does not directly affect their capital 
accounts). This allocation of the $10,000 portion of amount realized 
that exceeds the partnership's simulated adjusted basis in the lease 
will be treated as being in accordance with the partners' allocable 
shares of such amount realized under section 613A(c)(7)(D) because such 
allocation will not result in capital account adjustments (under 
paragraph (b)(2)(iv)(k) of this section) the economic effect of which is 
insubstantial, and all other partnership allocations are recognized 
under this paragraph. Under paragraph (b)(2)(iv)(k) of this section, the 
partners' capital accounts are adjusted upward by the partnership's 
simulated gain of $10,000 ($100,000 sales price less $90,000 simulated 
adjusted basis) in proportion to such partners' allocable shares of the 
$10,000 portion of the total amount realized that exceeds the 
partnership's $90,000 simulated adjusted basis ($5,000 to JC and $5,000 
to DG). If the lease is sold for $50,000, under paragraph (b)(4)(v) of 
this section the entire $50,000 amount realized on the sale of the lease 
will be allocated to DG (but will not directly affect his capital 
account). Under paragraph (b)(2)(iv)(k) of this section the partners' 
capital accounts will be adjusted downward by the partnership's $40,000 
simulated loss ($50,000 sales price less $90,000 simulated adjusted 
basis) in proportion to the partners' allocable shares of the total 
amount realized from the property that represents recovery of the 
partnership's simulated adjusted basis therein. Accordingly, DG's 
capital account will be reduced by such $40,000.

    (c) Contributed property; cross-reference. See Sec. 1.704-3 for 
methods of making allocations that take into account precontribution 
appreciation or diminution in value of property contributed by a partner 
to a partnership.
    (d) Limitation on allowance of losses. (1) A partner's distributive 
share of partnership loss will be allowed only to the extent of the 
adjusted basis (before reduction by current year's losses) of such 
partner's interest in the partnership at the end of the partnership 
taxable year in which such loss occurred. A partner's share of loss in 
excess of his adjusted basis at the end of the partnership taxable year 
will not be allowed for that year. However, any loss so disallowed shall 
be allowed as a deduction at the end of the first succeeding partnership 
taxable year, and subsequent partnership taxable years, to the extent 
that the partner's adjusted basis for his partnership interest at the 
end of any such year exceeds zero (before reduction by such loss for 
such year).
    (2) In computing the adjusted basis of a partner's interest for the 
purpose of ascertaining the extent to which a partner's distributive 
share of partnership loss shall be allowed as a deduction for the 
taxable year, the basis shall first be increased under section 705(a)(1) 
and decreased under section 705(a)(2), except for losses of the taxable 
year and losses previously disallowed. If the partner's distributive 
share of the aggregate of items of loss specified in section 702(a) (1), 
(2), (3), (8), and (9) exceeds the basis of the partner's interest 
computed under the preceding sentence, the limitation on losses under 
section 704(d) must be allocated to his distributive share of each such 
loss. This allocation shall be determined by taking the proportion that 
each loss bears to the total of all

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such losses. For purposes of the preceding sentence, the total losses 
for the taxable year shall be the sum of his distributive share of 
losses for the current year and his losses disallowed and carried 
forward from prior years.
    (3) For the treatment of certain liabilities of the partner or 
partnership, see section 752 and Sec. 1.752-1.
    (4) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. At the end of the partnership taxable year 1955, 
partnership AB has a loss of $20,000. Partner A's distributive share of 
this loss is $10,000. At the end of such year, A's adjusted basis for 
his interest in the partnership (not taking into account his 
distributive share of the loss) is $6,000. Under section 704(d), A's 
distributive share of partnership loss is allowed to him (in his taxable 
year within or with which the partnership taxable year ends) only to the 
extent of his adjusted basis of $6,000. The $6,000 loss allowed for 1955 
decreases the adjusted basis of A's interest to zero. Assume that, at 
the end of partnership taxable year 1956, A's share of partnership 
income has increased the adjusted basis of A's interest in the 
partnership to $3,000 (not taking into account the $4,000 loss 
disallowed in 1955). Of the $4,000 loss disallowed for the partnership 
taxable year 1955, $3,000 is allowed A for the partnership taxable year 
1956, thus again decreasing the adjusted basis of his interest to zero. 
If, at the end of partnership taxable year 1957, A has an adjusted basis 
of his interest of at least $1,000 (not taking into account the 
disallowed loss of $1,000), he will be allowed the $1,000 loss 
previously disallowed.
    Example 2. At the end of partnership taxable year 1955, partnership 
CD has a loss of $20,000. Partner C's distributive share of this loss is 
$10,000. The adjusted basis of his interest in the partnership (not 
taking into account his distributive share of such loss) is $6,000. 
Therefore, $4,000 of the loss is disallowed. At the end of partnership 
taxable year 1956, the partnership has no taxable income or loss, but 
owes $8,000 to a bank for money borrowed. Since C's share of this 
liability is $4,000, the basis of his partnership interest is increased 
from zero to $4,000. (See sections 752 and 722, and Secs. 1.752-1 and 
1.722-1.) C is allowed the $4,000 loss, disallowed for the preceding 
year under section 704(d), for his taxable year within or with which 
partnership taxable year 1956 ends.
    Example 3. At the end of partnership taxable year 1955, partner C 
has the following distributive share of partnership items described in 
section 702(a): Long-term capital loss, $4,000; short-term capital loss, 
$2,000; income as described in section 702(a)(9), $4,000. Partner C's 
adjusted basis for his partnership interest at the end of 1955, before 
adjustment for any of the above items, is $1,000. As adjusted under 
section 705(a)(1)(A), C's basis is increased from $1,000 to $5,000 at 
the end of the year. C's total distributive share of partnership loss is 
$6,000. Since without regard to losses, C has a basis of only $5,000, C 
is allowed only $5,000/$6,000 of each loss, that is, $3,333 of his long-
term capital loss, and $1,667 of his short-term capital loss. C must 
carry forward to succeeding taxable years $667 as a long-term capital 
loss and $333 as a short-term capital loss.

    (e) Family partnerships--(1) In general--(i) Introduction. The 
production of income by a partnership is attributable to the capital or 
services, or both, contributed by the partners. The provisions of 
subchapter K, chapter 1 of the Code, are to be read in the light of 
their relationship to section 61, which requires, inter alia, that 
income be taxed to the person who earns it through his own labor and 
skill and the utilization of his own capital.
    (ii) Recognition of donee as partner. With respect to partnerships 
in which capital is a material income-producing factor, section 
704(e)(1) provides that a person shall be recognized as a partner for 
income tax purposes if he owns a capital interest in such a partnership 
whether or not such interest is derived by purchase or gift from any 
other person. If a capital interest in a partnership in which capital is 
a material income-producing factor is created by gift, section 704(e)(2) 
provides that the distributive share of the donee under the partnership 
agreement shall be includible in his gross income, except to the extent 
that such distributive share is determined without allowance of 
reasonable compensation for services rendered to the partnership by the 
donor, and except to the extent that the portion of such distributive 
share attributable to donated capital is proportionately greater than 
the share of the donor attributable to the donor's capital. For rules of 
allocation in such cases, see subparagraph (3) of this paragraph.
    (iii) Requirement of complete transfer to donee. A donee or 
purchaser of a capital interest in a partnership is not recognized as a 
partner under the principles of section 704(e)(1) unless such interest 
is acquired in a bona fide transaction, not a mere sham for tax 
avoidance or

[[Page 341]]

evasion purposes, and the donee or purchaser is the real owner of such 
interest. To be recognized, a transfer must vest dominion and control of 
the partnership interest in the transferee. The existence of such 
dominion and control in the donee is to be determined from all the facts 
and circumstances. A transfer is not recognized if the transferor 
retains such incidents of ownership that the transferee has not acquired 
full and complete ownership of the partnership interest. Transactions 
between members of a family will be closely scrutinized, and the 
circumstances, not only at the time of the purported transfer but also 
during the periods preceding and following it, will be taken into 
consideration in determining the bona fides or lack of bona fides of the 
purported gift or sale. A partnership may be recognized for income tax 
purposes as to some partners but not as to others.
    (iv) Capital as a material income-producing factor. For purposes of 
section 704(e)(1), the determination as to whether capital is a material 
income-producing factor must be made by reference to all the facts of 
each case. Capital is a material income-producing factor if a 
substantial portion of the gross income of the business is attributable 
to the employment of capital in the business conducted by the 
partnership. In general, capital is not a material income-producing 
factor where the income of the business consists principally of fees, 
commissions, or other compensation for personal services performed by 
members or employees of the partnership. On the other hand, capital is 
ordinarily a material income-producing factor if the operation of the 
business requires substantial inventories or a substantial investment in 
plant, machinery, or other equipment.
    (v) Capital interest in a partnership. For purposes of section 
704(e), a capital interest in a partnership means an interest in the 
assets of the partnership, which is distributable to the owner of the 
capital interest upon his withdrawal from the partnership or upon 
liquidation of the partnership. The mere right to participate in the 
earnings and profits of a partnership is not a capital interest in the 
partnership.
    (2) Basic tests as to ownership--(i) In general. Whether an alleged 
partner who is a donee of a capital interest in a partnership is the 
real owner of such capital interest, and whether the donee has dominion 
and control over such interest, must be ascertained from all the facts 
and circumstances of the particular case. Isolated facts are not 
determinative; the reality of the donee's ownership is to be determined 
in the light of the transaction as a whole. The execution of legally 
sufficient and irrevocable deeds or other instruments of gift under 
State law is a factor to be taken into account but is not determinative 
of ownership by the donee for the purposes of section 704(e). The 
reality of the transfer and of the donee's ownership of the property 
attributed to him are to be ascertained from the conduct of the parties 
with respect to the alleged gift and not by any mechanical or formal 
test. Some of the more important factors to be considered in determining 
whether the donee has acquired ownership of the capital interest in a 
partnership are indicated in subdivisions (ii) to (x), inclusive, of 
this subparagraph.
    (ii) Retained controls. The donor may have retained such controls of 
the interest which he has purported to transfer to the donee that the 
donor should be treated as remaining the substantial owner of the 
interest. Controls of particular significance include, for example, the 
following:
    (a) Retention of control of the distribution of amounts of income or 
restrictions on the distributions of amounts of income (other than 
amounts retained in the partnership annually with the consent of the 
partners, including the donee partner, for the reasonable needs of the 
business). If there is a partnership agreement providing for a managing 
partner or partners, then amounts of income may be retained in the 
partnership without the acquiescence of all the partners if such amounts 
are retained for the reasonable needs of the business.
    (b) Limitation of the right of the donee to liquidate or sell his 
interest in the partnership at his discretion without financial 
detriment.
    (c) Retention of control of assets essential to the business (for 
example,

[[Page 342]]

through retention of assets leased to the alleged partnership).
    (d) Retention of management powers inconsistent with normal 
relationships among partners. Retention by the donor of control of 
business management or of voting control, such as is common in ordinary 
business relationships, is not by itself to be considered as 
inconsistent with normal relationships among partners, provided the 
donee is free to liquidate his interest at his discretion without 
financial detriment. The donee shall not be considered free to liquidate 
his interest unless, considering all the facts, it is evident that the 
donee is independent of the donor and has such maturity and 
understanding of his rights as to be capable of deciding to exercise, 
and capable of exercising, his right to withdraw his capital interest 
from the partnership.

The existence of some of the indicated controls, though amounting to 
less than substantial ownership retained by the donor, may be considered 
along with other facts and circumstances as tending to show the lack of 
reality of the partnership interest of the donee.
    (iii) Indirect controls. Controls inconsistent with ownership by the 
donee may be exercised indirectly as well as directly, for example, 
through a separate business organization, estate, trust, individual, or 
other partnership. Where such indirect controls exist, the reality of 
the donee's interest will be determined as if such controls were 
exercisable directly.
    (iv) Participation in management. Substantial participation by the 
donee in the control and management of the business (including 
participation in the major policy decisions affecting the business) is 
strong evidence of a donee partner's exercise of dominion and control 
over his interest. Such participation presupposes sufficient maturity 
and experience on the part of the donee to deal with the business 
problems of the partnership.
    (v) Income distributions. The actual distribution to a donee partner 
of the entire amount or a major portion of his distributive share of the 
business income for the sole benefit and use of the donee is substantial 
evidence of the reality of the donee's interest, provided the donor has 
not retained controls inconsistent with real ownership by the donee. 
Amounts distributed are not considered to be used for the donee's sole 
benefit if, for example, they are deposited, loaned, or invested in such 
manner that the donor controls or can control the use or enjoyment of 
such funds.
    (vi) Conduct of partnership business. In determining the reality of 
the donee's ownership of a capital interest in a partnership, 
consideration shall be given to whether the donee is actually treated as 
a partner in the operation of the business. Whether or not the donee has 
been held out publicly as a partner in the conduct of the business, in 
relations with customers, or with creditors or other sources of 
financing, is of primary significance. Other factors of significance in 
this connection include:
    (a) Compliance with local partnership, fictitious names, and 
business registration statutes.
    (b) Control of business bank accounts.
    (c) Recognition of the donee's rights in distributions of 
partnership property and profits.
    (d) Recognition of the donee's interest in insurance policies, 
leases, and other business contracts and in litigation affecting 
business.
    (e) The existence of written agreements, records, or memoranda, 
contemporaneous with the taxable year or years concerned, establishing 
the nature of the partnership agreement and the rights and liabilities 
of the respective partners.
    (f) Filing of partnership tax returns as required by law.

However, despite formal compliance with the above factors, other 
circumstances may indicate that the donor has retained substantial 
ownership of the interest purportedly transferred to the donee.
    (vii) Trustees as partners. A trustee may be recognized as a partner 
for income tax purposes under the principles relating to family 
partnerships generally as applied to the particular facts of the trust-
partnership arrangement. A trustee who is unrelated to and independent 
of the grantor, and who participates as a partner and receives 
distribution of the income distributable

[[Page 343]]

to the trust, will ordinarily be recognized as the legal owner of the 
partnership interest which he holds in trust unless the grantor has 
retained controls inconsistent with such ownership. However, if the 
grantor is the trustee, or if the trustee is amenable to the will of the 
grantor, the provisions of the trust instrument (particularly as to 
whether the trustee is subject to the responsibilities of a fiduciary), 
the provisions of the partnership agreement, and the conduct of the 
parties must all be taken into account in determining whether the 
trustee in a fiduciary capacity has become the real owner of the 
partnership interest. Where the grantor (or person amenable to his will) 
is the trustee, the trust may be recognized as a partner only if the 
grantor (or such other person) in his participation in the affairs of 
the partnership actively represents and protects the interests of the 
beneficiaries in accordance with the obligations of a fiduciary and does 
not subordinate such interests to the interests of the grantor. 
Furthermore, if the grantor (or person amenable to his will) is the 
trustee, the following factors will be given particular consideration:
    (a) Whether the trust is recognized as a partner in business 
dealings with customers and creditors, and
    (b) Whether, if any amount of the partnership income is not properly 
retained for the reasonable needs of the business, the trust's share of 
such amount is distributed to the trust annually and paid to the 
beneficiaries or reinvested with regard solely to the interests of the 
beneficiaries.
    (viii) Interests (not held in trust) of minor children. Except where 
a minor child is shown to be competent to manage his own property and 
participate in the partnership activities in accordance with his 
interest in the property, a minor child generally will not be recognized 
as a member of a partnership unless control of the property is exercised 
by another person as fiduciary for the sole benefit of the child, and 
unless there is such judicial supervision of the conduct of the 
fiduciary as is required by law. The use of the child's property or 
income for support for which a parent is legally responsible will be 
considered a use for the parent's benefit. ``Judicial supervision of the 
conduct of the fiduciary'' includes filing of such accountings and 
reports as are required by law of the fiduciary who participates in the 
affairs of the partnership on behalf of the minor. A minor child will be 
considered as competent to manage his own property if he actually has 
sufficient maturity and experience to be treated by disinterested 
persons as competent to enter business dealings and otherwise to conduct 
his affairs on a basis of equality with adult persons, notwithstanding 
legal disabilities of the minor under State law.
    (ix) Donees as limited partners. The recognition of a donee's 
interest in a limited partnership will depend, as in the case of other 
donated interests, on whether the transfer of property is real and on 
whether the donee has acquired dominion and control over the interest 
purportedly transferred to him. To be recognized for Federal income tax 
purposes, a limited partnership must be organized and conducted in 
accordance with the requirements of the applicable State limited-
partnership law. The absence of services and participation in management 
by a donee in a limited partnership is immaterial if the limited 
partnership meets all the other requirements prescribed in this 
paragraph. If the limited partner's right to transfer or liquidate his 
interest is subject to substantial restrictions (for example, where the 
interest of the limited partner is not assignable in a real sense or 
where such interest may be required to be left in the business for a 
long term of years), or if the general partner retains any other control 
which substantially limits any of the rights which would ordinarily be 
exercisable by unrelated limited partners in normal business 
relationships, such restrictions on the right to transfer or liquidate, 
or retention of other control, will be considered strong evidence as to 
the lack of reality of ownership by the donee.
    (x) Motive. If the reality of the transfer of interest is 
satisfactorily established, the motives for the transaction are 
generally immaterial. However, the presence or absence of a tax-
avoidance motive is one of many factors to be considered in determining 
the reality

[[Page 344]]

of the ownership of a capital interest acquired by gift.
    (3) Allocation of family partnership income--(i) In general. (a) 
Where a capital interest in a partnership in which capital is a material 
income-producing factor is created by gift, the donee's distributive 
share shall be includible in his gross income, except to the extent that 
such share is determined without allowance of reasonable compensation 
for services rendered to the partnership by the donor, and except to the 
extent that the portion of such distributive share attributable to 
donated capital is proportionately greater than the distributive share 
attributable to the donor's capital. For the purpose of section 704, a 
capital interest in a partnership purchased by one member of a family 
from another shall be considered to be created by gift from the seller, 
and the fair market value of the purchased interest shall be considered 
to be donated capital. The ``family'' of any individual, for the purpose 
of the preceding sentence, shall include only his spouse, ancestors, and 
lineal descendants, and any trust for the primary benefit of such 
persons.
    (b) To the extent that the partnership agreement does not allocate 
the partnership income in accordance with (a) of this subdivision, the 
distributive shares of the partnership income of the donor and donee 
shall be reallocated by making a reasonable allowance for the services 
of the donor and by attributing the balance of such income (other than a 
reasonable allowance for the services, if any, rendered by the donee) to 
the partnership capital of the donor and donee. The portion of income, 
if any, thus attributable to partnership capital for the taxable year 
shall be allocated between the donor and donee in accordance with their 
respective interests in partnership capital.
    (c) In determining a reasonable allowance for services rendered by 
the partners, consideration shall be given to all the facts and 
circumstances of the business, including the fact that some of the 
partners may have greater managerial responsibility than others. There 
shall also be considered the amount that would ordinarily be paid in 
order to obtain comparable services from a person not having an interest 
in the partnership.
    (d) The distributive share of partnership income, as determined 
under (b) of this subdivision, of a partner who rendered services to the 
partnership before entering the Armed Forces of the United States shall 
not be diminished because of absence due to military service. Such 
distributive share shall be adjusted to reflect increases or decreases 
in the capital interest of the absent partner. However, the partners may 
by agreement allocate a smaller share to the absent partner due to his 
absence.
    (ii) Special rules. (a) The provisions of subdivision (i) of this 
subparagraph, relating to allocation of family partnership income, are 
applicable where the interest in the partnership is created by gift, 
indirectly or directly. Where the partnership interest is created 
indirectly, the term donor may include persons other than the nominal 
transferor. This rule may be illustrated by the following examples:

    Example 1. A father gives property to his son who shortly thereafter 
conveys the property to a partnership consisting of the father and the 
son. The partnership interest of the son may be considered created by 
gift and the father may be considered the donor of the son's partnership 
interest.
    Example 2. A father, the owner of a business conducted as a sole 
proprietorship, transfers the business to a partnership consisting of 
his wife and himself. The wife subsequently conveys her interest to 
their son. In such case, the father, as well as the mother, may be 
considered the donor of the son's partnership interest.
    Example 3. A father makes a gift to his son of stock in the family 
corporation. The corporation is subsequently liquidated. The son later 
contributes the property received in the liquidation of the corporation 
to a partnership consisting of his father and himself. In such case, for 
purposes of section 704, the son's partnership interest may be 
considered created by gift and the father may be considered the donor of 
his son's partnership interest.

    (b) The allocation rules set forth in section 704(e) and subdivision 
(i) of this subparagraph apply in any case in which the transfer or 
creation of the partnership interest has any of the substantial 
characteristics of a gift. Thus, allocation may be required where 
transfer of a partnership interest is

[[Page 345]]

made between members of a family (including collaterals) under a 
purported purchase agreement, if the characteristics of a gift are 
ascertained from the terms of the purchase agreement, the terms of any 
loan or credit arrangements made to finance the purchase, or from other 
relevant data.
    (c) In the case of a limited partnership, for the purpose of the 
allocation provisions of subdivision (i) of this subparagraph, 
consideration shall be given to the fact that a general partner, unlike 
a limited partner, risks his credit in the partnership business.
    (4) Purchased interest--(i) In general. If a purported purchase of a 
capital interest in a partnership does not meet the requirements of 
subdivision (ii) of this subparagraph, the ownership by the transferee 
of such capital interest will be recognized only if it qualifies under 
the requirements applicable to a transfer of a partnership interest by 
gifts. In a case not qualifying under subdivision (ii) of this 
subparagraph, if payment of any part of the purchase price is made out 
of partnership earnings, the transaction may be regarded in the same 
light as a purported gift subject to deferred enjoyment of income. Such 
a transaction may be lacking in reality either as a gift or as a bona 
fide purchase.
    (ii) Tests as to reality of purchased interests. A purchase of a 
capital interest in a partnership, either directly or by means of a loan 
or credit extended by a member of the family, will be recognized as bona 
fide if:
    (a) It can be shown that the purchase has the usual characteristics 
of an arm's-length transaction, considering all relevant factors, 
including the terms of the purchase agreement (as to price, due date of 
payment, rate of interest, and security, if any) and the terms of any 
loan or credit arrangement collateral to the purchase agreement; the 
credit standing of the purchaser (apart from relationship to the seller) 
and the capacity of the purchaser to incur a legally binding obligation; 
or
    (b) It can be shown, in the absence of characteristics of an arm's-
length transaction, that the purchase was genuinely intended to promote 
the success of the business by securing participation of the purchaser 
in the business or by adding his credit to that of the other 
participants.

However, if the alleged purchase price or loan has not been paid or the 
obligation otherwise discharged, the factors indicated in (a) and (b) of 
this subdivision shall be taken into account only as an aid in 
determining whether a bona fide purchase or loan obligation existed.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6771, 29 FR 
15571, Nov. 20, 1964; T.D. 8065, 50 FR 53423, Dec. 31, 1985; 51 FR 
10826, Mar. 31, 1986; T.D. 8099, 51 FR 32062, 32068-32070, Sept. 9, 
1986; 52 FR 10223, Mar. 31, 1987; T.D. 8237, 53 FR 53173, Dec. 30, 1988; 
T.D. 8385, 56 FR 66983, Dec. 27, 1991; 57 FR 11430, Apr. 3, 1992; T.D. 
8500, 58 FR 67679, Dec. 22, 1993; T.D. 8585, 59 FR 66728, Dec. 28, 1994]



Sec. 1.704-2  Allocations attributable to nonrecourse liabilities.

    (a) Table of contents. This paragraph contains a listing of the 
major headings of this Sec. 1.704-2.
    Sec. 1.704-2  Allocations attributable to nonrecourse liabilities.
    (a) Table of contents.
    (b) General principles and definitions.
    (1) Definition of and allocations of nonrecourse deductions.
    (2) Definition of and allocations pursuant to a minimum gain 
chargeback.
    (3) Definition of nonrecourse liability.
    (4) Definition of partner nonrecourse debt.
    (c) Amount of nonrecourse deductions.
    (d) Partnership minimum gain.
    (1) Amount of partnership minimum gain.
    (2) Property subject to more than one liability.
    (i) In general.
    (ii) Allocating liabilities.
    (3) Partnership minimum gain if there is a book/tax disparity.
    (4) Special rule for year of revaluation.
    (e) Requirements to be satisfied.
    (f) Minimum gain chargeback requirement.
    (1) In general.
    (2) Exception for certain conversions and refinancings.
    (3) Exception for certain capital contributions.
    (4) Waiver for certain income allocations that fail to meet minimum 
gain chargeback requirement if minimum gain chargeback distorts economic 
arrangement.
    (5) Additional exceptions.
    (6) Partnership items subject to the minimum gain chargeback 
requirement.
    (7) Examples.
    (g) Shares of partnership minimum gain.
    (1) Partner's share of partnership minimum gain.

[[Page 346]]

    (2) Partner's share of the net decrease in partnership minimum gain.
    (3) Conversions of recourse or partner nonrecourse debt into 
nonrecourse debt.
    (h) Distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain.
    (1) In general.
    (2) Distribution allocable to nonrecourse liability proceeds.
    (3) Option when there is an obligation to restore.
    (4) Carryover to immediately succeeding taxable year.
    (i) Partnership nonrecourse liabilities where a partner bears the 
economic risk of loss.
    (1) In general.
    (2) Definition of and determination of partner nonrecourse 
deductions.
    (3) Determination of partner nonrecourse debt minimum gain.
    (4) Chargeback of partner nonrecourse debt minimum gain.
    (5) Partner's share of partner nonrecourse debt minimum gain.
    (6) Distribution of partner nonrecourse debt proceeds allocable to 
an increase in partner nonrecourse debt minimum gain.
    (j) Ordering rules.
    (1) Treatment of partnership losses and deductions.
    (i) Partner nonrecourse deductions.
    (ii) Partnership nonrecourse deductions.
    (iii) Carryover to succeeding taxable year.
    (2) Treatment of partnership income and gains.
    (i) Minimum gain chargeback.
    (ii) Chargeback attributable to decrease in partner nonrecourse debt 
minimum gain.
    (iii) Carryover to succeeding taxable year.
    (k) Tiered partnerships.
    (1) Increase in upper-tier partnership's minimum gain.
    (2) Decrease in upper-tier partnership's minimum gain.
    (3) Nonrecourse debt proceeds distributed from the lower-tier 
partnership to the upper-tier partnership.
    (4) Nonrecourse deductions of lower-tier partnership treated as 
depreciation by upper-tier partnership.
    (5) Coordination with partner nonrecourse debt rules.
    (l) Effective dates.
    (1) In general.
    (i) Prospective application.
    (ii) Partnerships subject to temporary regulations.
    (iii) Partnerships subject to former regulations.
    (2) Special rule applicable to pre-January 30, 1989, related party 
nonrecourse debt.
    (3) Transition rule for pre-March 1, 1984, partner nonrecourse debt.
    (4) Election.
    (m) Examples.

    (b) General principles and definitions--(1) Definition of and 
allocations of nonrecourse deductions. Allocations of losses, 
deductions, or section 705(a)(2)(B) expenditures attributable to 
partnership nonrecourse liabilities (``nonrecourse deductions'') cannot 
have economic effect because the creditor alone bears any economic 
burden that corresponds to those allocations. Thus, nonrecourse 
deductions must be allocated in accordance with the partners' interests 
in the partnership. Paragraph (e) of this section provides a test that 
deems allocations of nonrecourse deductions to be in accordance with the 
partners' interests in the partnership. If that test is not satisfied, 
the partners' distributive shares of nonrecourse deductions are 
determined under Sec. 1.704-1(b)(3), according to the partners' overall 
economic interests in the partnership. See also paragraph (i) of this 
section for special rules regarding the allocation of deductions 
attributable to nonrecourse liabilities for which a partner bears the 
economic risk of loss (as described in paragraph (b)(4) of this 
section).
    (2) Definition of and allocations pursuant to a minimum gain 
chargeback. To the extent a nonrecourse liability exceeds the adjusted 
tax basis of the partnership property it encumbers, a disposition of 
that property will generate gain that at least equals that excess 
(``partnership minimum gain''). An increase in partnership minimum gain 
is created by a decrease in the adjusted tax basis of property 
encumbered by a nonrecourse liability below the amount of that liability 
and by a partnership nonrecourse borrowing that exceeds the adjusted tax 
basis of the property encumbered by the borrowing. Partnership minimum 
gain decreases as reductions occur in the amount by which the 
nonrecourse liability exceeds the adjusted tax basis of the property 
encumbered by the liability. Allocations of gain attributable to a 
decrease in partnership minimum gain (a ``minimum gain chargeback,'' as 
required under paragraph (f) of this section) cannot have economic 
effect because the gain merely offsets nonrecourse deductions previously 
claimed by the partnership. Thus, to avoid impairing the economic effect 
of other allocations, allocations

[[Page 347]]

pursuant to a minimum gain chargeback must be made to the partners that 
either were allocated nonrecourse deductions or received distributions 
of proceeds attributable to a nonrecourse borrowing. Paragraph (e) of 
this section provides a test that, if met, deems allocations of 
partnership income pursuant to a minimum gain chargeback to be in 
accordance with the partners' interests in the partnership. If property 
encumbered by a nonrecourse liability is reflected on the partnership's 
books at a value that differs from its adjusted tax basis, paragraph 
(d)(3) of this section provides that minimum gain is determined with 
reference to the property's book basis. See also paragraph (i)(4) of 
this section for special rules regarding the minimum gain chargeback 
requirement for partner nonrecourse debt.
    (3) Definition of nonrecourse liability. Nonrecourse liability means 
a nonrecourse liability as defined in Sec. 1.752-1(a)(2).
    (4) Definition of partner nonrecourse debt. Partner nonrecourse debt 
or partner nonrecourse liability means any partnership liability to the 
extent the liability is nonrecourse for purposes of Sec. 1.1001-2, and a 
partner or related person (within the meaning of Sec. 1.752-4(b)) bears 
the economic risk of loss under Sec. 1.752-2 because, for example, the 
partner or related person is the creditor or a guarantor.
    (c) Amount of nonrecourse deductions. The amount of nonrecourse 
deductions for a partnership taxable year equals the net increase in 
partnership minimum gain during the year (determined under paragraph (d) 
of this section), reduced (but not below zero) by the aggregate 
distributions made during the year of proceeds of a nonrecourse 
liability that are allocable to an increase in partnership minimum gain 
(determined under paragraph (h) of this section). See paragraph (m), 
Examples (1)(i) and (vi), (2), and (3) of this section. However, 
increases in partnership minimum gain resulting from conversions, 
refinancings, or other changes to a debt instrument (as described in 
paragraph (g)(3)) do not generate nonrecourse deductions. Generally, 
nonrecourse deductions consist first of certain depreciation or cost 
recovery deductions and then, if necessary, a pro rata portion of other 
partnership losses, deductions, and section 705(a)(2)(B) expenditures 
for that year; excess nonrecourse deductions are carried over. See 
paragraphs (j)(1) (ii) and (iii) of this section for more specific 
ordering rules. See also paragraph (m), Example (1)(iv) of this section.
    (d) Partnership minimum gain--(1) Amount of partnership minimum 
gain. The amount of partnership minimum gain is determined by first 
computing for each partnership nonrecourse liability any gain the 
partnership would realize if it disposed of the property subject to that 
liability for no consideration other than full satisfaction of the 
liability, and then aggregating the separately computed gains. The 
amount of partnership minimum gain includes minimum gain arising from a 
conversion, refinancing, or other change to a debt instrument, as 
described in paragraph (g)(3) of this section, only to the extent a 
partner is allocated a share of that minimum gain. For any partnership 
taxable year, the net increase or decrease in partnership minimum gain 
is determined by comparing the partnership minimum gain on the last day 
of the immediately preceding taxable year with the partnership minimum 
gain on the last day of the current taxable year. See paragraph (m), 
Examples (1) (i) and (iv), (2), and (3) of this section.
    (2) Property subject to more than one liability. (i) In general. If 
property is subject to more than one liability, only the portion of the 
property's adjusted tax basis that is allocated to a nonrecourse 
liability under paragraph (d)(2)(ii) of this section is used to compute 
minimum gain with respect to that liability.
    (ii) Allocating liabilities. If property is subject to two or more 
liabilities of equal priority, the property's adjusted tax basis is 
allocated among the liabilities in proportion to their outstanding 
balances. If property is subject to two or more liabilities of unequal 
priority, the adjusted tax basis is allocated first to the liability of 
the highest priority to the extent of its outstanding balance and then 
to each liability in descending order of priority to the extent of its 
outstanding balance, until fully

[[Page 348]]

allocated. See paragraph (m), Example (1) (v) and (vii) of this section.
    (3) Partnership minimum gain if there is a book/tax disparity. If 
partnership property subject to one or more nonrecourse liabilities is, 
under Sec. 1.704-1(b)(2)(iv) (d), (f), or (r), reflected on the 
partnership's books at a value that differs from its adjusted tax basis, 
the determinations under this section are made with reference to the 
property's book value. See section 704(c) and Sec. 1.704-1(b)(4)(i) for 
principles that govern the treatment of a partner's share of minimum 
gain that is eliminated by the revaluation. See also paragraph (m), 
Example (3) of this section.
    (4) Special rule for year of revaluation. If the partners' capital 
accounts are increased pursuant to Sec. 1.704-1(b)(2)(iv) (d), (f), or 
(r) to reflect a revaluation of partnership property subject to a 
nonrecourse liability, the net increase or decrease in partnership 
minimum gain for the partnership taxable year of the revaluation is 
determined by:
    (i) First calculating the net decrease or increase in partnership 
minimum gain using the current year's book values and the prior year's 
partnership minimum gain amount; and
    (ii) Then adding back any decrease in minimum gain arising solely 
from the revaluation.

See paragraph (m), Example (3)(iii) of this section. If the partners' 
capital accounts are decreased to reflect a revaluation, the net 
increases or decreases in partnership minimum gain are determined in the 
same manner as in the year before the revaluation, but by using book 
values rather than adjusted tax bases. See section 7701(g) and 
Sec. 1.704-1(b)(2)(iv)(f)(1) (property being revalued cannot be booked 
down below the amount of any nonrecourse liability to which the property 
is subject).
    (e) Requirements to be satisfied. Allocations of nonrecourse 
deductions are deemed to be in accordance with the partners' interests 
in the partnership only if--
    (1) Throughout the full term of the partnership requirements (1) and 
(2) of Sec. 1.704-1(b)(2)(ii)(b) are satisfied (i.e., capital accounts 
are maintained in accordance with Sec. 1.704-1(b)(2)(iv) and liquidating 
distributions are required to be made in accordance with positive 
capital account balances), and requirement (3) of either Sec. 1.704-
1(b)(2)(ii)(b) or Sec. 1.704-1(b)(2)(ii)(d) is satisfied (i.e., partners 
with deficit capital accounts have an unconditional deficit restoration 
obligation or agree to a qualified income offset);
    (2) Beginning in the first taxable year of the partnership in which 
there are nonrecourse deductions and thereafter throughout the full term 
of the partnership, the partnership agreement provides for allocations 
of nonrecourse deductions in a manner that is reasonably consistent with 
allocations that have substantial economic effect of some other 
significant partnership item attributable to the property securing the 
nonrecourse liabilities;
    (3) Beginning in the first taxable year of the partnership that it 
has nonrecourse deductions or makes a distribution of proceeds of a 
nonrecourse liability that are allocable to an increase in partnership 
minimum gain, and thereafter throughout the full term of the 
partnership, the partnership agreement contains a provision that 
complies with the minimum gain chargeback requirement of paragraph (f) 
of this section; and
    (4) All other material allocations and capital account adjustments 
under the partnership agreement are recognized under Sec. 1.704-1(b) 
(without regard to whether allocations of adjusted tax basis and amount 
realized under section 613A(c)(7)(D) are recognized under Sec. 1.704-
1(b)(4)(v)).
    (f) Minimum gain chargeback requirement--(1) In general. If there is 
a net decrease in partnership minimum gain for a partnership taxable 
year, the minimum gain chargeback requirement applies and each partner 
must be allocated items of partnership income and gain for that year 
equal to that partner's share of the net decrease in partnership minimum 
gain (within the meaning of paragraph (g)(2)).
    (2) Exception for certain conversions and refinancings. A partner is 
not subject to the minimum gain chargeback requirement to the extent the 
partner's share of the net decrease in partnership minimum gain is 
caused by a guarantee, refinancing, or other change in the debt 
instrument causing it to become partially or wholly recourse debt or

[[Page 349]]

partner nonrecourse debt, and the partner bears the economic risk of 
loss (within the meaning of Sec. 1.752-2) for the newly guaranteed, 
refinanced, or otherwise changed liability.
    (3) Exception for certain capital contributions. A partner is not 
subject to the minimum gain chargeback requirement to the extent the 
partner contributes capital to the partnership that is used to repay the 
nonrecourse liability or is used to increase the basis of the property 
subject to the nonrecourse liability, and the partner's share of the net 
decrease in partnership minimum gain results from the repayment or the 
increase to the property's basis. See paragraph (m), Example (1)(iv) of 
this section.
    (4) Waiver for certain income allocations that fail to meet minimum 
gain chargeback requirement if minimum gain chargeback distorts economic 
arrangement. In any taxable year that a partnership has a net decrease 
in partnership minimum gain, if the minimum gain chargeback requirement 
would cause a distortion in the economic arrangement among the partners 
and it is not expected that the partnership will have sufficient other 
income to correct that distortion, the Commissioner has the discretion, 
if requested by the partnership, to waive the minimum gain chargeback 
requirement. The following facts must be demonstrated in order for a 
request for a waiver to be considered:
    (i) The partners have made capital contributions or received net 
income allocations that have restored the previous nonrecourse 
deductions and the distributions attributable to proceeds of a 
nonrecourse liability; and
    (ii) The minimum gain chargeback requirement would distort the 
partners' economic arrangement as reflected in the partnership agreement 
and as evidenced over the term of the partnership by the partnership's 
allocations and distributions and the partners' contributions.
    (5) Additional exceptions. The Commissioner may, by revenue ruling, 
provide additional exceptions to the minimum gain chargeback 
requirement.
    (6) Partnership items subject to the minimum gain chargeback 
requirement. Any minimum gain chargeback required for a partnership 
taxable year consists first of certain gains recognized from the 
disposition of partnership property subject to one or more partnership 
nonrecourse liabilities and then if necessary consists of a pro rata 
portion of the partnership's other items of income and gain for that 
year. If the amount of the minimum gain chargeback requirement exceeds 
the partnership's income and gains for the taxable year, the excess 
carries over. See paragraphs (j)(2) (i) and (iii) of this section for 
more specific ordering rules.
    (7) Examples. The following examples illustrate the provisions in 
Sec. 1.704-2(f).

    Example 1. Partnership AB consists of two partners, limited partner 
A and general partner B. Partner A contributes $90 and Partner B 
contributes $10 to the partnership. The partnership agreement has a 
minimum gain chargeback provision and provides that, except as otherwise 
required by section 704(c), all losses will be allocated 90 percent to A 
and 10 percent to B; and that all income will be allocated first to 
restore previous losses and thereafter 50 percent to A and 50 percent to 
B. Distributions are made first to return initial capital to the 
partners and then 50 percent to A and 50 percent to B. Final 
distributions are made in accordance with capital account balances. The 
partnership borrows $200 on a nonrecourse basis from an unrelated third 
party and purchases an asset for $300. The partnership's only tax item 
for each of the first three years in $100 of depreciation on the asset. 
A's and B's shares of minimum gain (under paragraph (g) of this section) 
and deficit capital account balances are $180 and $20 respectively at 
the end of the third year. In the fourth year, the partnership earns 
$400 of net operating income and allocates the first $300 to restore the 
previous losses (i.e., $270 to A and $30 to B); the last $100 is 
allocated $50 each. The partnership distributes $200 of the available 
cash that same year; the first $100 is distributed $90 to A and $10 to B 
to return their capital contributions; the last $100 is distributed $50 
each to reflect their ratio for sharing profits.

------------------------------------------------------------------------
                                                           A        B   
------------------------------------------------------------------------
Capital account on formation..........................     $90      $10 
    Less: Net loss in years 1-3.......................   ($270)    ($30)
                                                       -----------------
Capital account at end of year 3......................   ($180)    ($20)
Allocation of operating income to restore nonrecourse                   
 deductions...........................................    $180      $20 
                                                       =================
Allocation of operating income to restore capital                       
 contributions........................................     $90      $10 
Allocation of operating income to reflect profits.....     $50      $50 
                                                       -----------------

[[Page 350]]

                                                                        
Capital accounts after allocation of operating income.    $140      $60 
Distribution reflecting capital contribution..........    ($90)    ($10)
Distribution in profit-sharing ratio..................    ($50)    ($50)
                                                       -----------------
Capital accounts following distribution...............     ($0)     ($0)
------------------------------------------------------------------------

In the fifth year, the partnership sells the property for $300 and 
realizes $300 of gain. $200 of the proceeds are used to pay the 
nonrecourse lender. The partnership has $300 to distribute, and the 
partners expect to share that equally. Absent a waiver under paragraph 
(f)(4) of this section, the minimum gain chargeback would require the 
partnership to allocate the first $200 of the gain $180 to A and $20 to 
B, which would distort their economic arrangement. This allocation, 
together with the allocation of the $100 profit $50 to each partner, 
would result in A having a positive capital account balance of $230 and 
B having a positive capital account balance of $70. The allocation of 
income in year 4 in effect anticipated the minimum gain chargeback that 
did not occur until year 5. Assuming the partnership would not have 
sufficient other income to correct the distortion that would otherwise 
result, the partnership may request that the Commissioner exercise his 
or her discretion to waive the minimum gain chargeback requirement and 
recognize allocations that would allow A and B to share equally the gain 
on the sale of the property. These allocations would bring the partners' 
capital accounts to $150 each, allowing them to share the last $300 
equally. The Commissioner may, in his or her discretion, permit this 
allocation pursuant to paragraph (f)(4) of this section because the 
minimum gain chargeback would distort the partners' economic arrangement 
over the term of the partnership as reflected in the partnership 
agreement and as evidenced by the partners' contributions and the 
partnership's allocations and distributions.
    Example 2. A and B form a partnership, contribute $25 each to the 
partnership's capital, and agree to share all losses and profits 50 
percent each. Neither partner has an unconditional deficit restoration 
obligation and all the requirements in paragraph (e) of this section are 
met. The partnership obtains a nonrecourse loan from an unrelated third 
party of $100 and purchases two assets, stock for $50 and depreciable 
property for $100. The nonrecourse loan is secured by the partnership's 
depreciable property. The partnership generates $20 of depreciation in 
each of the first five years as its only tax item. These deductions are 
properly treated as nonrecourse deductions and the allocation of these 
deductions 50 percent to A and 50 percent to B is deemed to be in 
accordance with the partners' interests in the partnership. At the end 
of year five, A and B each have a $25 deficit capital account and a $50 
share of partnership minimum gain. In the beginning of year six, (at the 
lender's request), A guarantees the entire nonrecourse liability. 
Pursuant to paragraph (d)(1) of this section, the partnership has a net 
decrease in minimum gain of $100 and under paragraph (g)(2) of this 
section, A's and B's shares of that net decrease are $50 each. Under 
paragraph (f)(1) of this section (the minimum gain chargeback 
requirement), B is subject to a $50 minimum gain chargeback. Because the 
partnership has no gross income in year six, the entire $50 carries over 
as a minimum gain chargeback requirement to succeeding taxable years 
until their is enough income to cover the minimum gain chargeback 
requirement. Under the exception to the minimum gain chargeback in 
paragraph (f)(2) of this section, A is not subject to a minimum gain 
chargeback for A's $50 share of the net decrease because A bears the 
economic risk of loss for the liability. Instead, A's share of partner 
nonrecourse debt minimum gain is $50 pursuant to paragraph (i)(3) of 
this section. In year seven, the partnership earns $100 of net operating 
income and uses the money to repay the entire $100 nonrecourse debt 
(that A has guaranteed). Under paragraph (i)(3) of this section, the 
partnership has a net decrease in partner nonrecourse debt minimum gain 
of $50. B must be allocated $50 of the operating income pursuant to the 
carried over minimum gain chargeback requirement; pursuant to paragraph 
(i)(4) of this section, the other $50 of operating income must be 
allocated to A as a partner nonrecourse debt minimum gain chargeback.

    (g) Shares of partnership minimum gain--(1) Partner's share of 
partnership minimum gain. Except as increased in paragraph (g) (3) of 
this section, a partner's share of partnership minimum gain at the end 
of any partnership taxable year equals:
    (i) The sum of nonrecourse deductions allocated to that partner (and 
to that partner's predecessors in interest) up to that time and the 
distributions made to that partner (and to that partner's predecessors' 
in interest) up to that time of proceeds of a nonrecourse liability 
allocable to an increase in partnership minimum gain (see paragraph 
(h)(1) of this section); minus
    (ii) The sum of that partner's (and that partner's predecessors' in 
interest) aggregate share of the net decreases in partnership minimum 
gain plus their aggregate share of decreases resulting

[[Page 351]]

from revaluations of partnership property subject to one or more 
partnership nonrecourse liabilities.

For purposes of Sec. 1.704-1(b)(2)(ii)(d), a partner's share of 
partnership minimum gain is added to the limited dollar amount, if any, 
of the deficit balance in the partner's capital account that the partner 
is obligated to restore. See paragraph (m), Examples (1)(i) and (3)(i) 
of this section.
    (2) Partner's share of the net decrease in partnership minimum gain. 
A partner's share of the net decrease in partnership minimum gain is the 
amount of the total net decrease multiplied by the partner's percentage 
share of the partnership's minimum gain at the end of the immediately 
preceding taxable year. A partner's share of any decrease in partnership 
minimum gain resulting from a revaluation of partnership property equals 
the increase in the partner's capital account attributable to the 
revaluation to the extent the reduction in minimum gain is caused by the 
revaluation. See paragraph (m), Example (3)(ii) of this section.
    (3) Conversions of recourse or partner nonrecourse debt into 
nonrecourse debt. A partner's share of partnership minimum gain is 
increased to the extent provided in this paragraph (g)(3) if a 
refinancing, the lapse of a guarantee, or other change to a debt 
instrument causes a recourse or partner nonrecourse liability to become 
partially or wholly nonrecourse. If a recourse liability becomes a 
nonrecourse liability, a partner has a share of the partnership's 
minimum gain that results from the conversion equal to the partner's 
deficit capital account (determined under Sec. 1.704-1(b)(2)(iv)) to the 
extent the partner no longer bears the economic burden for the entire 
deficit capital account as a result of the conversion. For purposes of 
the preceding sentence, the determination of the extent to which a 
partner bears the economic burden for a deficit capital account is made 
by determining the consequences to the partner in the case of a complete 
liquidation of the partnership immediately after the conversion applying 
the rules described in Sec. 1.704-1(b)(2)(iii)(c) that deem the value of 
partnership property to equal its basis, taking into account section 
7701(g) in the case of property that secures nonrecourse indebtedness. 
If a partner nonrecourse debt becomes a nonrecourse liability, the 
partner's share of partnership minimum gain is increased to the extent 
the partner is not subject to the minimum gain chargeback requirement 
under paragraph (i)(4) of this section.
    (h) Distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain--(1) In general. If during its 
taxable year a partnership makes a distribution to the partners 
allocable to the proceeds of a nonrecourse liability, the distribution 
is allocable to an increase in partnership minimum gain to the extent 
the increase results from encumbering partnership property with 
aggregate nonrecourse liabilities that exceed the property's adjusted 
tax basis. See paragraph (m), Example (1)(vi) of this section. If the 
net increase in partnership minimum gain for a partnership taxable year 
is allocable to more than one nonrecourse liability, the net increase is 
allocated among the liabilities in proportion to the amount each 
liability contributed to the increase in minimum gain.
    (2) Distribution allocable to nonrecourse liability proceeds. A 
partnership may use any reasonable method to determine whether a 
distribution by the partnership to one or more partners is allocable to 
proceeds of a nonrecourse liability. The rules prescribed under 
Sec. 1.163-8T for allocating debt proceeds among expenditures (applying 
those rules to the partnership as if it were an individual) constitute a 
reasonable method for determining whether the nonrecourse liability 
proceeds are distributed to the partners and the partners to whom the 
proceeds are distributed.
    (3) Option when there is an obligation to restore. A partnership may 
treat any distribution to a partner of the proceeds of a nonrecourse 
liability (that would otherwise be allocable to an increase in 
partnership minimum gain) as a distribution that is not allocable to an 
increase in partnership minimum gain to the extent the distribution does 
not cause or increase a deficit balance in the partner's capital account 
that

[[Page 352]]

exceeds the amount the partner is otherwise obligated to restore (within 
the meaning of Sec. 1.704-1(b)(2)(ii)(c)) as of the end of the 
partnership taxable year in which the distribution occurs.
    (4) Carryover to immediately succeeding taxable year. The carryover 
rule of this paragraph applies if the net increase in partnership 
minimum gain for a partnership taxable year that is allocable to a 
nonrecourse liability under paragraph (h)(2) of this section exceeds the 
distributions allocable to the proceeds of the liability (``excess 
allocable amount''), and all or part of the net increase in partnership 
minimum gain for the year is carried over as an increase in partnership 
minimum gain for the immediately succeeding taxable year (pursuant to 
paragraph (j)(1)(iii) of this section). If the carryover rule of this 
paragraph applies, the excess allocable amount (or the amount carried 
over under paragraph (j)(1)(iii) of this section, if less) is treated in 
the succeeding taxable year as an increase in partnership minimum gain 
that arose in that year as a result of incurring the nonrecourse 
liability to which the excess allocable amount is attributable. See 
paragraph (m), Example (1)(vi) of this section. If for a partnership 
taxable year there is an excess allocable amount with respect to more 
than one partnership nonrecourse liability, the excess allocable amount 
is allocated to each liability in proportion to the amount each 
liability contributed to the increase in minimum gain.
    (i) Partnership nonrecourse liabilities where a partner bears the 
economic risk of loss--(1) In general. Partnership losses, deductions, 
or section 705(a)(2)(B) expenditures that are attributable to a 
particular partner nonrecourse liability (``partner nonrecourse 
deductions,'' as defined in paragraph (i)(2) of this section) must be 
allocated to the partner that bears the economic risk of loss for the 
liability. If more than one partner bears the economic risk of loss for 
a partner nonrecourse liability, any partner nonrecourse deductions 
attributable to that liability must be allocated among the partners 
according to the ratio in which they bear the economic risk of loss. If 
partners bear the economic risk of loss for different portions of a 
liability, each portion is treated as a separate partner nonrecourse 
liability.
    (2) Definition of and determination of partner nonrecourse 
deductions. For any partnership taxable year, the amount of partner 
nonrecourse deductions with respect to a partner nonrecourse debt equals 
the net increase during the year in minimum gain attributable to the 
partner nonrecourse debt (``partner nonrecourse debt minimum gain''), 
reduced (but not below zero) by proceeds of the liability distributed 
during the year to the partner bearing the economic risk of loss for the 
liability that are both attributable to the liability and allocable to 
an increase in the partner nonrecourse debt minimum gain. See paragraph 
(m), Example (1) (viii) and (ix) of this section. The determination of 
which partnership items constitute the partner nonrecourse deductions 
with respect to a partner nonrecourse debt must be made in a manner 
consistent with the provisions of paragraphs (c) and (j)(1) (i) and 
(iii) of this section.
    (3) Determination of partner nonrecourse debt minimum gain. For any 
partnership taxable year, the determination of partner nonrecourse debt 
minimum gain and the net increase or decrease in partner nonrecourse 
debt minimum gain must be made in a manner consistent with the 
provisions of paragraphs (d) and (g)(3) of this section.
    (4) Chargeback of partner nonrecourse debt minimum gain. If during a 
partnership taxable year there is a net decrease in partner nonrecourse 
debt minimum gain, any partner with a share of that partner nonrecourse 
debt minimum gain (determined under paragraph (i)(5) of this section) as 
of the beginning of the year must be allocated items of income and gain 
for the year (and, if necessary, for succeeding years) equal to that 
partner's share of the net decrease in the partner nonrecourse debt 
minimum gain. A partner's share of the net decrease in partner 
nonrecourse debt minimum gain is determined in a manner consistent with 
the provisions of paragraph (g)(2) of this section. A partner is not 
subject to this minimum gain chargeback, however, to the extent the net 
decrease in partner nonrecourse debt minimum gain arises

[[Page 353]]

because the liability ceases to be partner nonrecourse debt due to a 
conversion, refinancing, or other change in the debt instrument that 
causes it to become partially or wholly a nonrecourse liability. The 
amount that would otherwise be subject to the partner nonrecourse debt 
minimum gain chargeback is added to the partner's share of partnership 
minimum gain under paragraph (g)(3) of this section. In addition, rules 
consistent with the provisions of paragraphs (f) (2), (3), (4), and (5) 
of this section apply with respect to partner nonrecourse debt in 
appropriate circumstances. The determination of which items of 
partnership income and gain must be allocated pursuant to this paragraph 
(i)(4) is made in a manner that is consistent with the provisions of 
paragraph (f)(6) of this section. See paragraph (j)(2) (ii) and (iii) of 
this section for more specific rules.
    (5) Partner's share of partner nonrecourse debt minimum gain. A 
partner's share of partner nonrecourse debt minimum gain at the end of 
any partnership taxable year is determined in a manner consistent with 
the provisions of paragraphs (g)(1) and (g)(3) of this section with 
respect to each particular partner nonrecourse debt for which the 
partner bears the economic risk of loss. For purposes of Sec. 1.704-
1(b)(2)(ii)(d), a partner's share of partner nonrecourse debt minimum 
gain is added to the limited dollar amount, if any, of the deficit 
balance in the partner's capital account that the partner is obligated 
to restore, and the partner is not otherwise considered to have a 
deficit restoration obligation as a result of bearing the economic risk 
of loss for any partner nonrecourse debt. See paragraph (m), Example 
(1)(viii) of this section.
    (6) Distribution of partner nonrecourse debt proceeds allocable to 
an increase in partner nonrecourse debt minimum gain. Rules consistent 
with the provisions of paragraph (h) of this section apply to 
distributions of the proceeds of partner nonrecourse debt.
    (j) Ordering rules. For purposes of this section, the following 
ordering rules apply to partnership items. Notwithstanding any other 
provision in this section and Sec. 1.704-1, allocations of partner 
nonrecourse deductions, nonrecourse deductions, and minimum gain 
chargebacks are made before any other allocations.
    (1) Treatment of partnership losses and deductions. (i) Partner 
nonrecourse deductions. Partnership losses, deductions, and section 
705(a)(2)(B) expenditures are treated as partner nonrecourse deductions 
in the amount determined under paragraph (i)(2) of this section 
(determining partner nonrecourse deductions) in the following order:
    (A) First, depreciation or cost recovery deductions with respect to 
property that is subject to partner nonrecourse debt;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other deductions, losses, and section 705(a)(2)(B) items.

Depreciation or cost recovery deductions with respect to property that 
is subject to a partnership nonrecourse liability is first treated as a 
partnership nonrecourse deduction and any excess is treated as a partner 
nonrecourse deduction under this paragraph (j)(1)(i).
    (ii) Partnership nonrecourse deductions. Partnership losses, 
deductions, and section 705(a)(2)(B) expenditures are treated as 
partnership nonrecourse deductions in the amount determined under 
paragraph (c) of this section (determining nonrecourse deductions) in 
the following order:
    (A) First, depreciation or cost recovery deductions with respect to 
property that is subject to partnership nonrecourse liabilities;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other deductions, losses, and section 705(a)(2)(B) items.

Depreciation or cost recovery deductions with respect to property that 
is subject to partner nonrecourse debt is first treated as a partner 
nonrecourse deduction and any excess is treated as a partnership 
nonrecourse deduction under this paragraph (j)(1)(ii). Any other item 
that is treated as a partner nonrecourse deduction will in no event be 
treated as a partnership nonrecourse deduction.

[[Page 354]]

    (iii) Carryover to succeeding taxable year. If the amount of partner 
nonrecourse deductions or nonrecourse deductions exceeds the 
partnership's losses, deductions, and section 705(a)(2)(B) expenditures 
for the taxable year (determined under paragraphs (j)(1) (i) and (ii) of 
this section), the excess is treated as an increase in partner 
nonrecourse debt minimum gain or partnership minimum gain in the 
immediately succeeding partnership taxable year. See paragraph (m), 
Example (1)(vi) of this section.
    (2) Treatment of partnership income and gains. (i) Minimum gain 
chargeback. Items of partnership income and gain equal to the minimum 
gain chargeback requirement (determined under paragraph (f) of this 
section) are allocated as a minimum gain chargeback in the following 
order:
    (A) First, gain from the disposition of property subject to 
partnership nonrecourse liabilities;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other items of income and gain for that year.

Gain from the disposition of property subject to partner nonrecourse 
debt is allocated to satisfy a minimum gain chargeback requirement for 
partnership nonrecourse debt only to the extent not allocated under 
paragraph (j)(2)(ii) of this section.
    (ii) Chargeback attributable to decrease in partner nonrecourse debt 
minimum gain. Items of partnership income and gain equal to the partner 
nonrecourse debt minimum gain chargeback (determined under paragraph 
(i)(4) of this section) are allocated to satisfy a partner nonrecourse 
debt minimum gain chargeback in the following order:
    (A) First, gain from the disposition of property subject to partner 
nonrecourse debt;
    (B) Then, if necessary, a pro rata portion of the partnership's 
other items of income and gain for that year.

Gain from the disposition of property subject to a partnership 
nonrecourse liability is allocated to satisfy a partner nonrecourse debt 
minimum gain chargeback only to the extent not allocated under paragraph 
(j)(2)(i) of this section. An item of partnership income and gain that 
is allocated to satisfy a minimum gain chargeback under paragraph (f) of 
this section is not allocated to satisfy a minimum gain chargeback under 
paragraph (i)(4).
    (iii) Carryover to succeeding taxable year. If a minimum gain 
chargeback requirement (determined under paragraphs (f) and (i)(4) of 
this section) exceeds the partnership's income and gains for the taxable 
year, the excess is treated as a minimum gain chargeback requirement in 
the immediately succeeding partnership taxable years until fully charged 
back.
    (k) Tiered partnerships. For purposes of this section, the following 
rules determine the effect on partnership minimum gain when a 
partnership (``upper-tier partnership'') is a partner in another 
partnership (``lower-tier partnership'').
    (1) Increase in upper-tier partnership's minimum gain. The sum of 
the nonrecourse deductions that the lower-tier partnership allocates to 
the upper-tier partnership for any taxable year of the upper-tier 
partnership, and the distributions made during that taxable year from 
the lower-tier partnership to the upper-tier partnership of proceeds of 
nonrecourse debt that are allocable to an increase in the lower-tier 
partnership's minimum gain, is treated as an increase in the upper-tier 
partnership's minimum gain.
    (2) Decrease in upper-tier partnership's minimum gain. The upper-
tier partnership's share for its taxable year of the lower-tier 
partnership's net decrease in its minimum gain is treated as a decrease 
in the upper-tier partnership's minimum gain for that taxable year.
    (3) Nonrecourse debt proceeds distributed from the lower-tier 
partnership to the upper-tier partnership. All distributions from the 
lower-tier partnership to the upper-tier partnership during the upper-
tier partnership's taxable year of proceeds of a nonrecourse liability 
allocable to an increase in the lower-tier partnership's minimum gain 
are treated as proceeds of a nonrecourse liability of the upper-tier 
partnership. The increase in the upper-tier partnership's minimum gain 
(under paragraph (k)(1) of this section) attributable to the receipt of 
those distributions is, for purposes of paragraph (h) of this section, 
treated as an increase in the upper-tier

[[Page 355]]

partnership's minimum gain arising from encumbering property of the 
upper-tier partnership with a nonrecourse liability of the upper-tier 
partnership.
    (4) Nonrecourse deductions of lower-tier partnership treated as 
depreciation by upper-tier partnership. For purposes of paragraph (c) of 
this section, all nonrecourse deductions allocated by the lower-tier 
partnership to the upper-tier partnership for the upper-tier 
partnership's taxable year are treated as depreciation or cost recovery 
deductions with respect to property owned by the upper-tier partnership 
and subject to a nonrecourse liability of the upper-tier partnership 
with respect to which minimum gain increased during the year by the 
amount of the nonrecourse deductions.
    (5) Coordination with partner nonrecourse debt rules. The lower-tier 
partnership's liabilities that are treated as the upper-tier 
partnership's liabilities under Sec. 1.752-4(a) are treated as the 
upper-tier partnership's liabilities for purposes of applying paragraph 
(i) of this section. Rules consistent with the provisions of paragraphs 
(k)(1) through (k)(4) of this section apply to determine the allocations 
that the upper-tier partnership must make with respect to any liability 
that constitutes a nonrecourse debt for which one or more partners of 
the upper-tier partnership bear the economic risk of loss.
    (l) Effective dates--(1) In general--(i) Prospective application. 
Except as otherwise provided in this paragraph (l), this section applies 
for partnership taxable years beginning on or after December 28, 1991. 
For the rules applicable to taxable years beginning after December 29, 
1988, and before December 28, 1991, see former Sec. 1.704-1T(b)(4)(iv). 
For the rules applicable to taxable years beginning on or before 
December 29, 1988, see former Sec. 1.704-1(b)(4)(iv).
    (ii) Partnerships subject to temporary regulations. If a partnership 
agreement entered into after December 29, 1988, and before December 28, 
1991, or a partnership agreement entered into on or before December 29, 
1988, that elected to apply former Sec. 1.704-1T(b)(4)(iv) (as contained 
in the CFR edition revised as of April 1, 1991), complied with the 
provisions of former Sec. 1.704-1T(b)(4)(iv) before December 28, 1991--
    (A) The provisions of former Sec. 1.704-1T(b)(4)(iv) continue to 
apply to the partnership for any taxable year beginning on or after 
December 28, 1991, (unless the partnership makes an election under 
paragraph (l)(4) of this section) and ending before any subsequent 
material modification to the partnership agreement; and
    (B) The provisions of this section do not apply to the partnership 
for any of those taxable years.
    (iii) Partnerships subject to former regulations. If a partnership 
agreement entered into on or before December 29, 1988, complied with the 
provisions of former Sec. 1.704-1(b)(4)(iv)(d) on or before that date--
    (A) The provisions of former Sec. 1.704-1(b)(4)(iv) (a) through (f) 
continue to apply to the partnership for any taxable year beginning 
after that date (unless the partnership made an election under 
Sec. 1.704-1T(b)(4)(iv)(m)(4) in a partnership taxable year ending 
before December 28, 1991, or makes an election under paragraph (l)(4) of 
this section) and ending before any subsequent material modification to 
the partnership agreement; and
    (B) The provisions of this section do not apply to the partnership 
for any of those taxable years.
    (2) Special rule applicable to pre-January 30, 1989, related party 
nonrecourse debt. For purposes of this section and former Sec. 1.704-
1T(b)(4)(iv), if--
    (i) A partnership liability would, but for this paragraph (l)(2) of 
this section, constitute a partner nonrecourse debt; and
    (ii) Sections 1.752-1 through 1.752-3 or former Secs. 1.752-1T 
through -3T (whichever is applicable) do not apply to the liability;

the liability is, notwithstanding paragraphs (i) and (b)(4) of this 
section, treated as a nonrecourse liability of the partnership, and not 
as a partner nonrecourse debt, to the extent the liability would be so 
treated under this section (or Sec. 1.704-1T(b)(4)(iv)) if the 
determination of the extent to which one or more partners bears the 
economic risk of loss for the liability under Sec. 1.752-1 or former 
Sec. 1.752-1T were made without regard to the economic risk of

[[Page 356]]

loss that any partner would otherwise be considered to bear for the 
liability by reason of any obligation undertaken or interest as a 
creditor acquired prior to January 30, 1989, by a person related to the 
partner (within the meaning of Sec. 1.752-4(b) or former Sec. 1.752-
1T(h)). For purposes of the preceding sentence, if a related person 
undertakes an obligation or acquires an interest as a creditor on or 
after January 30, 1989, pursuant to a written binding contract in effect 
prior to January 30, 1989, and at all times thereafter, the obligation 
or interest as a creditor is treated as if it were undertaken or 
acquired prior to January 30, 1989. However, for partnership taxable 
years beginning on or after December 29, 1988, a pre-January 30, 1989, 
liability, other than a liability subject to paragraph (l)(3) of this 
section or former Sec. 1.704-1T(b)(4)(iv)(m)(3) (whichever is 
applicable), that is treated as grandfathered under former Secs. 1.752-
1T through -3T (whichever is applicable) will be treated as a 
nonrecourse liability for purposes of this section provided that all 
partners in the partnership consistently treat the liability as 
nonrecourse for partnership taxable years beginning on or after December 
29, 1988.
    (3) Transition rule for pre-March 1, 1984, partner nonrecourse debt. 
If a partnership liability would, but for this paragraph (l)(3) or 
former Sec. 1.704-1T(b)(4)(iv), constitute a partner nonrecourse debt 
and the liability constitutes grandfathered partner nonrecourse debt 
that is appropriately treated as a nonrecourse liability of the 
partnership under Sec. 1.752-1 (as in effect prior to December 29, 
1988)--
    (i) The liability is, notwithstanding paragraphs (i) and (b)(4) of 
this section, former Sec. 1.704-1T(b)(4)(iv), and former Sec. 1.704-
1(b)(4)(iv), treated as a nonrecourse liability of the partnership for 
purposes of this section and for purposes of former Sec. 1.704-
1T(b)(4)(iv) and former Sec. 1.704-1(b)(4)(iv) to the extent of the 
amount, if any, by which the smallest outstanding balance of the 
liability during the period beginning at the end of the first 
partnership taxable year ending on or after December 31, 1986, and 
ending at the time of any determination under this paragraph (l)(3)(i) 
or former Sec. 1.704-1T(b)(4)(iv)(m)(3)(i) exceeds the aggregate amount 
of the adjusted basis (or book value) of partnership property allocable 
to the liability (determined in accordance with former Sec. 1.704-
1(b)(4)(iv)(c) (1) and (2) at the end of the first partnership taxable 
year ending on or after December 31, 1986); and
    (ii) In applying this section to the liability, former Sec. 1.704-
1(b)(4)(iv)(c) (1) and (2) is applied as if all of the adjusted basis of 
partnership property allocable to the liability is allocable to the 
portion of the liability that is treated as a partner nonrecourse debt 
and as if none of the adjusted basis of partnership property that is 
allocable to the liability is allocable to the portion of the liability 
that is treated as a nonrecourse liability under this paragraph (l)(3) 
and former Sec. 1.704-1T (b)(4)(iv)(m)(3)(i).

For purposes of the preceding sentence, a grandfathered partner debt is 
any partnership liability that was not subject to former Secs. 1.752-1T 
and -3T but that would have been subject to those sections under 
Sec. 1.752-4T(b) if the liability had arisen (other than pursuant to a 
written binding contract) on or after March 1, 1984. A partnership 
liability is not considered to have been subject to Secs. 1.752-2T and -
3T solely because a portion of the liability was treated as a liability 
to which those sections apply under Sec. 1.752-4(e).
    (4) Election. A partnership may elect to apply the provisions of 
this section to the first taxable year of the partnership ending on or 
after December 28, 1991. An election under this paragraph (l)(4) is made 
by attaching a written statement to the partnership return for the first 
taxable year of the partnership ending on or after December 28, 1991. 
The written statement must include the name, address, and taxpayer 
identification number of the partnership making the statement and must 
declare that an election is made under this paragraph (l)(4).
    (m) Examples. The principles of this section are illustrated by the 
following examples:

    Example 1. Nonrecourse deductions and partnerships minimum gain. For 
Example 1, unless otherwise provided, the following facts are assumed. 
LP, the limited partner, and GP,

[[Page 357]]

deficit balance in GP's capital account following the liquidation of 
GP's interest (as set forth in Sec. 1.704-1 (b) (2)(ii)(b)(3)), and LP 
will not be required to restore any deficit balance in LP's capital 
account following the liquidation of LP's interest. The partnership 
agreement contains the following provisions required by paragraph (e) of 
this section: a qualified income offset (as defined in Sec. 1.704-
1(b)(2)(ii)(d)); a minimum gain chargeback (in accordance with paragraph 
(f) of this section); a provision that the partners' capital accounts 
will be determined and maintained in accordance with Sec. 1.704-
1(b)(2)(ii)(b)(1); and a provision that distributions will be made in 
accordance with partners' positive capital account balances (as set 
forth in Sec. 1.704-1(b)(2)(ii)(b)(2)). In addition, as of the end of 
each partnership taxable year discussed herein, the items described in 
Sec. 1.704-1(b)(2)(ii)(d) (4), (5), and (6) are not reasonably expected 
to cause or increase a deficit balance in LP's capital account. The 
partnership agreement provides that, except as otherwise required by its 
qualified income offset and minimum gain chargeback provisions, all 
partnership items will be allocated 90 percent to LP and 10 percent to 
GP until the first time when the partnership has recognized items of 
income and gain that exceed the items of loss and deduction it has 
recognized over its life, and all further partnership items will be 
allocated equally between LP and GP. Finally, the partnership agreement 
provides that all distributions, other than distributions in liquidation 
of the partnership or of a partner's interest in the partnership, will 
be made 90 percent to LP and 10 percent to GP until a total of $200,000 
has been distributed, and thereafter all the distributions will be made 
equally to LP and GP. In each of the partnership's first 2 taxable 
years, it generates rental income of $95,000, operating expenses 
(including land lease payments) of $10,000, in- 
terest expense of $80,000, and a depreciation deduction of $90,000, 
resulting in a net taxable loss of $85,000 in each of those years. The 
allocations of these losses 90 per percent to LP and 10 percent to GP 
have substantial economic effect.

------------------------------------------------------------------------
                                                       LP          GP   
------------------------------------------------------------------------
Capital account on formation.....................   $180,000    $20,000 
    Less: net loss in years 1 and 2..............   (153,000)   (17,000)
                                                  ----------------------
Capital account at end of year 2.................    $27,000     $3,000 
------------------------------------------------------------------------

In the partnership's third taxable year, it again generates rental 
income of $95,000, operating expenses of $10,000, interest expense of 
$80,000, and a depreciation deduction of $90,000, resulting in net 
taxable loss of $85,000. The partnership makes no distributions.
    (i) Calculation of nonrecourse deductions and partnership minimum 
gain. If the partnership were to dispose of the building in full 
satisfaction of the nonrecourse liability at the end of the third year, 
it would realize $70,000 of gain ($800,000 amount realized less $730,000 
adjusted tax basis). Because the amount of partnership minimum gain at 
the end of the third year (and the net increase in partnership minimum 
gain during the year) is $70,000, there are partnership nonrecourse 
deductions for that year of $70,000, consisting of depreciation 
deductions allowable with respect to the building of $70,000. Pursuant 
to the partnership agreement, all partnership items comprising the net 
taxable loss of $85,000, including the $70,000 nonrecourse deduction, 
are allocated 90 percent to LP and 10 percent to GP. The allocation of 
these items, other than the nonrecourse deductions, has substantial 
economic effect.

------------------------------------------------------------------------
                                                       LP          GP   
------------------------------------------------------------------------
Capital account at end of year 2.................    $27,000     $3,000 
    Less: net loss in year 3 (without nonrecourse                       
     deductions).................................    (13,500)    (1,500)
    Less: nonrecourse deductions in year 3.......    (63,000)    (7,000)
                                                  ----------------------
Capital account at end of year 3.................   ($49,500)   ($5,500)
------------------------------------------------------------------------


[[Page 358]]

The allocation of the $70,000 nonrecourse deduction satisfies 
requirement (2) of paragraph (e) of this section because it is 
consistent with allocations having substantial economic effect of other 
significant partnership items attributable to the building. Because the 
remaining requirements of paragraph (e) of this section are satisfied, 
the allocation of nonrecourse deductions is deemed to be in accordance 
with the partners' interests in the partnership. At the end of the 
partnership's third taxable year, LP's and GP's shares of partnership 
minimum gain are $63,000 and $7,000, respectively. Therefore, pursuant 
to paragraph (g)(1) of this section, LP is treated as obligated to 
restore a deficit capital account balance of $63,000, so that in the 
succeeding year LP could be allocated up to an additional $13,500 of 
partnership deductions, losses, and section 705(a)(2)(B) items that are 
not nonrecourse deductions. Even though this allocation would increase a 
deficit capital account balance, it would be considered to have economic 
effect under the alternate economic effect test contained in Sec. 1.704-
1(b)(2)(ii)(d). If the partnership were to dispose of the building in 
full satisfaction of the nonrecourse liability at the beginning of the 
partnership's fourth taxable year (and had no other economic activity in 
that year), the partnership minimum gain would be decreased from $70,000 
to zero, and the minimum gain chargeback would require that LP and GP be 
allocated $63,000 and $7,000, respectively, of the gain from that 
disposition.
    (ii) Illustration of reasonable consistency requirement. Assume 
instead that the partnership agreement provides that all nonrecourse 
deductions of the partnership will be allocated equally between LP and 
GP. Furthermore, at the time the partnership agreement is entered into, 
there is a reasonable likelihood that over the partnership's life it 
will realize amounts of income and gain significantly in excess of 
amounts of loss and deduction (other than nonrecourse deductions). The 
equal allocation of excess income and gain has substantial economic 
effect.

------------------------------------------------------------------------
                                                       LP          GP   
------------------------------------------------------------------------
Capital account on formation.....................   $180,000    $20,000 
    Less: net loss in years 1 and 2..............   (153,000)   (17,000)
    Less: net loss in year (without nonrecourse                         
     deductions).................................    (13,500)    (1,500)
    Less: nonrecourse deductions in year 3.......    (35,000)   (35,000)
                                                  ----------------------
Capital account at end of year 3.................   ($21,500)  ($33,500)
------------------------------------------------------------------------

The allocation of the $70,000 nonrecourse deduction equally between LP 
and GP satisfies requirement (2) of paragraph (e) of this section 
because the allocation is consistent with allocations, which will have 
substantial economic effect, of other significant partnership items 
attributable to the building. Because the remaining requirements of 
paragraph (e) of this section are satisfied, the allocation of 
nonrecourse deductions is deemed to be in accordance with the partners' 
interests in the partnership. The allocation of the nonrecourse 
deductions 75 percent to LP and 25 percent to GP (or in any other ratio 
between 90 percent to LP/10 percent to GP and 50 percent to LP/50 
percent to GP) also would satisfy requirement (2) of paragraph (e) of 
this section.
    (iii) Allocation of nonrecourse deductions that fails reasonable 
consistency requirement. Assume instead that the partnership agreement 
provides that LP will be allocated 99 percent, and GP 1 percent, of all 
nonrecourse deductions of the partnership. Allocating nonrecourse 
deductions this way does not satisfy requirement (2) of paragraph (e) of 
this section because the allocations are not reasonably consistent with 
allocations, having substantial economic effect, of any other 
significant partnership item attributable to the building. Therefore, 
the allocation of nonrecourse deductions will be disregarded, and the 
nonrecourse deductions of the partnership will be reallocated according 
to the partners' overall economic interests in the partnership, 
determined under Sec. 1.704-1(b)(3)(ii).
    (iv) Capital contribution to pay down nonrecourse debt. At the 
beginning of the partnership's fourth taxable year, LP contributes 
$144,000 and GP contributes $16,000 of addition capital to the 
partnership, which the partnership immediately uses to reduce the amount 
of its nonrecourse liability from $800,000 to $640,000. In addition, in 
the partnership's fourth taxable year, it generates rental income of 
$95,000, operating expenses of $10,000, interest expense of $64,000 
(consistent with the debt reduction), and a depreciation deduction of 
$90,000, resulting in a net taxable loss of $69,000. If the partnership 
were to dispose of the building in full satisfaction of the nonrecourse 
liability at the end of that year, it would realize no gain ($640,000 
amount realized less $640,000 adjusted tax basis). Therefore, the amount 
of partnership minimum gain at the end of the year is zero, which 
represents a net decrease in partnership minimum gain of $70,000 during 
the year. LP's and GP's shares of this net decrease are $63,000 and 
$7,000 respectively, so that at the end of the partnership's fourth 
taxable year, LP's and GP's shares of partnership minimum gain are zero. 
Although there has been a net decrease in partnership minimum gain, 
pursuant to paragraph (f)(3)

[[Page 359]]

of this section LP and GP are not subject to a minimum gain chargeback.

------------------------------------------------------------------------
                                                       LP          GP   
------------------------------------------------------------------------
Capital account at end of year 3.................   ($49,500)   ($5,500)
    Plus: contribution...........................    144,000     16,000 
    Less: net loss in year 4.....................    (62,100)    (6,900)
                                                  ----------------------
Capital account at end of year 4.................    $32,400     $3,600 
Minimum gain chargeback carryforward.............         $0         $0 
------------------------------------------------------------------------

    (v) Loans of unequal priority. Assume instead that the building 
acquired by the partnership is secured by a $700,000 nonrecourse loan 
and a $100,000 recourse loan, subordinate in priority to the nonrecourse 
loan. Under paragraph (d)(2) of this section, $700,000 of the adjusted 
basis of the building at the end of the partnership's third taxable year 
is allocated to the nonrecourse liability (with the remaining $30,000 
allocated to the recourse liability) so that if the partnership disposed 
of the building in full satisfaction of the nonrecourse liability at the 
end of that year, it would realize no gain ($700,000 amount realized 
less $700,000 adjusted tax basis). Therefore, there is no minimum gain 
(or increase in minimum gain) at the end of the partnership's third 
taxable year. If, however, the $700,000 nonrecourse loan were 
subordinate in priority to the $100,000 recourse loan, under paragraph 
(d)(2) of this section, the first $100,000 of adjusted tax basis in the 
building would be allocated to the recourse liability, leaving only 
$630,000 of the adjusted basis of the building to be allocated to the 
$700,000 nonrecourse loan. In that case, the balance of the $700,000 
nonrecourse liability would exceed the adjusted tax basis of the 
building by $70,000, so that there would be $70,000 of minimum gain (and 
a $70,000 increase in partnership minimum gain) in the partnership's 
third taxable year.
    (vi) Nonrecourse borrowing; distribution of proceeds in subsequent 
year. The partnership obtains an additional nonrecourse loan of $200,000 
at the end of its fourth taxable year, secured by a second mortgage on 
the building, and distributes $180,000 of this cash to its partners at 
the beginning of its fifth taxable year. In addition, in its fourth and 
fifth taxable years, the partnership again generates rental income of 
$95,000, operating expenses of $10,000, interest expense of $80,000 
($100,000 in the fifth taxable year reflecting the interest paid on both 
liabilities), and a depreciation deduction of $90,000, resulting in a 
net taxable loss of $85,000 ($105,000 in the fifth taxable year 
reflecting the interest paid on both liabilities). The partnership has 
distributed its $5,000 of operating cash flow in each year ($95,000 of 
rental income less $10,000 of operating expense and $80,000 of interest 
expense) to LP and GP at the end of each year. If the partnership were 
to dispose of the building in full satisfaction of both nonrecourse 
liabilities at the end of its fourth taxable year, the partnership would 
realize $360,000 of gain ($1,000,000 amount realized less $640,000 
adjusted tax basis). Thus, the net increase in partnership minimum gain 
during the partnership's fourth taxable year is $290,000 ($360,000 of 
minimum gain at the end of the fourth year less $70,000 of minimum gain 
at the end of the third year). Because the partnership did not 
distribute any of the proceeds of the loan it obtained in its fourth 
year during that year, the potential amount of partnership nonrecourse 
deductions for that year is $290,000. Under paragraph (c) of this 
section, if the partnership had distributed the proceeds of that loan to 
its partners at the end of its fourth year, the partnership's 
nonrecourse deductions for that year would have been reduced by the 
amount of that distribution because the proceeds of that loan are 
allocable to an increase in partnership minimum gain under paragraph 
(h)(1) of this section. Because the nonrecourse deductions of $290,000 
for the partnership's fourth taxable year exceed its total deductions 
for that year, all $180,000 of the partnership's deductions for that 
year are treated as nonrecourse deductions, and the $110,000 excess 
nonrecourse deductions are treated as an increase in partnership minimum 
gain in the partnership's fifth taxable year under paragraph (c) of this 
section.

------------------------------------------------------------------------
                                                       LP          GP   
------------------------------------------------------------------------
Capital account at end of year 3 (including cash                        
 flow distributions).............................   ($63,000)   ($7,000)
Plus: rental income in year 4....................     85,500      9,500 
    Less: nonrecourse deductions in year 4.......   (162,000)   (18,000)
    Less: cash flow distributions in year 4......     (4,500)      (500)
                                                  ----------------------
Capital account at end of year 4.................  ($144,000)  ($16,000)
------------------------------------------------------------------------


[[Page 360]]

At the end of the partnership's fourth taxable year, LP's and GP's 
shares of partnership minimum gain are $225,000 and $25,000, 
respectively (because the $110,000 excess of nonrecourse deductions is 
carried forward to the next year). If the partnership were to dispose of 
the building in full satisfaction of the nonrecourse liabilities at the 
end of its fifth taxable year, the partnership would realize $450,000 of 
gain ($1,000,000 amount realized less $550,000 adjusted tax basis). 
Therefore, the net increase in partnership minimum gain during the 
partnership's fifth taxable year is $200,000 ($110,000 deemed increase 
plus the $90,000 by which minimum gain at the end of the fifth year 
exceeds minimum gain at the end of the fourth year ($450,000 less 
$360,000)). At the beginning of its fifth year, the partnership 
distributes $180,000 of the loan proceeds (retaining $20,000 to pay the 
additional interest expense). Under paragraph (h) of this section, the 
first $110,000 of this distribution (an amount equal to the deemed 
increase in partnership minimum gain for the year) is considered 
allocable to an increase in partnership minimum gain for the year. As a 
result, the amount of nonrecourse deductions for the partnership's fifth 
taxable year is $90,000 ($200,000 net increase in minimum gain less 
$110,000 distribution of nonrecourse liability proceeds allocable to an 
increase in partnership minimum gain), and the nonrecourse deductions 
consist solely of the $90,000 depreciation deduction allowable with 
respect to the building. As a result of the distributions during the 
partnership's fifth taxable year, the total distributions to the 
partners over the partnership's life equal $205,000. Therefore, the last 
$5,000 distributed to the partners during the fifth year will be divided 
equally between them under the partnership agreement. Thus, out of the 
$185,000 total distribution during the partnership's fifth taxable year, 
the first $180,000 is distributed 90 percent to LP and 10 percent to GP, 
and the last $5,000 is divided equally between them.

------------------------------------------------------------------------
                                                      LP          GP    
------------------------------------------------------------------------
Capital account at end of year 4...............   ($144,000)   ($16,000)
    Less: net loss in year 5 (without                                   
     nonrecourse deductions)...................     (13,500)     (1,500)
    Less: nonrecourse deductions in year 5.....     (81,000)     (9,000)
    Less: distribution of loan proceeds........    (162,000)    (18,000)
    Less: cash flow distribution in year 5.....      (2,500)     (2,500)
                                                ------------------------
Capital account at end of year 5...............   ($403,000)   ($47,000)
------------------------------------------------------------------------

At the end of the partnership's fifth taxable year, LP's share of 
partnership minimum gain is $405,000 ($225,000 share of minimum gain at 
the end of the fourth year plus $81,000 of nonrecourse deductions for 
the fifth year and a $99,000 distribution of nonrecourse liability 
proceeds that are allocable to an increase in minimum gain) and GP's 
share of partnership minimum gain is $45,000 ($25,000 share of minimum 
gain at the end of the fourth year plus $9,000 of nonrecourse deductions 
for the fifth year and an $11,000 distribution of nonrecourse liability 
proceeds that are allocable to an increase in minimum gain).
    (vii) Partner guarantee of nonrecourse debt. LP and GP personally 
guarantee the ``first'' $100,000 of the $800,000 nonrecourse loan (i.e., 
only if the building is worth less than $100,000 will they be called 
upon to make up any deficiency). Under paragraph (d)(2) of this section, 
only $630,000 of the adjusted tax basis of the building is allocated to 
the $700,000 nonrecourse portion of the loan because the collateral will 
be applied first to satisfy the $100,000 guaranteed portion, making it 
superior in priority to the remainder of the loan. On the other hand, if 
LP and GP were to guarantee the ``last'' $100,000 (i.e., if the building 
is worth less than $800,000, they will be called upon to make up the 
deficiency up to $100,000), $700,000 of the adjusted tax basis of the 
building would be allocated to the $700,000 nonrecourse portion of the 
loan because the guaranteed portion would be inferior in priority to it.
    (viii) Partner nonrecourse debt. Assume instead that the $800,000 
loan is made by LP, the limited partner. Under paragraph (b)(4) of this 
section, the $800,000 obligation does not constitute a nonrecourse 
liability of the partnership for purposes of this section because LP, a 
partner, bears the economic risk of loss for that loan within the 
meaning of Sec. 1.752-2. Instead, the $800,000 loan constitutes a 
partner nonrecourse debt under paragraph (b)(4) of this section. In the 
partnership's third taxable year, partnership minimum gain would have 
increased by $70,000 if the debt were a nonrecourse liability of the 
partnership. Thus, under paragraph (i)(3) of this section, there is a 
net increase of $70,000 in the minimum gain attributable to the $800,000 
partner nonrecourse debt for the partnership's third taxable year, and 
$70,000 of the $90,000 depreciation deduction from the building for the 
partnership's third taxable year constitutes a partner nonrecourse 
deduction with respect to the debt. See paragraph (i)(4) of this 
section. Under paragraph (i)(2) of this section, this partner 
nonrecourse deduction must be allocated to LP, the partner that bears 
the economic risk of loss for that liability.
    (ix) Nonrecourse debt and partner nonrecourse debt of differing 
priorities. As in Example 1 (viii) of this paragraph (m), the $800,000

[[Page 361]]

loan is made to the partnership by LP, the limited partner, but the loan 
is a purchase money loan that ``wraps around'' a $700,000 underlying 
nonrecourse note (also secured by the building) issued by LP to an 
unrelated person in connection with LP's acquisition of the building. 
Under these circumstances, LP bears the economic risk of loss with 
respect to only $100,000 of the liability within the meaning of 
Sec. 1.752-2. See Sec. 1.752-2(f) (Example 6). Therefore, for purposes 
of paragraph (d) of this section, the $800,000 liability is treated as a 
$700,000 nonrecourse liability of the partnership and a $100,000 partner 
nonrecourse debt (inferior in priority to the $700,000 liability) of the 
partnership for which LP bears the economic risk of loss. Under 
paragraph (i)(2) of this section, $70,000 of the $90,000 depreciation 
deduction realized in the partnership's third taxable year constitutes a 
partner nonrecourse deduction that must be allocated to LP.
    Example 2. Netting of increases and decreases in partnership minimum 
gain. For Example 2 unless otherwise provided, the following facts are 
assumed. X and Y form a general partnership to acquire and operate 
residential real properties. Each partner contributes $150,000 to the 
partnership. The partnership obtains a $1,500,000 nonrecourse loan and 
purchases 3 apartment buildings (on leased land) for $720,000 
(``Property A''), $540,000 (``Property B''), and $540,000 (``Property 
C''). The nonrecourse loan is secured only by the 3 buildings, and no 
principal payments are due for 5 years. In each of the partnership's 
first 3 taxable years, it generates rental income of $225,000, operating 
expenses (including land lease payments) of $50,000, interest expense of 
$175,000, and depreciation deductions on the 3 properties of $150,000 
($60,000 on Property A and $45,000 on each of Property B and Property 
C), resulting in a net taxable loss of $150,000 in each of those years. 
The partnership makes no distributions to X or Y.
    (i) Calculation of net increases and decreases in partnership 
minimum gain. If the partnership were to dispose of the 3 apartment 
buildings in full satisfaction of its nonrecourse liability at the end 
of its third taxable year, it would realize $150,000 of gain ($1,500,000 
amount realized less $1,350,000 adjusted tax basis). Because the amount 
of partnership minimum gain at the end of that year (and the net 
increase in partnership minimum gain during that year) is $150,000, the 
amount of partnership nonrecourse deductions for that year is $150,000, 
consisting of depreciation deductions allowable with respect to the 3 
apartment buildings of $150,000. The result would be the same if the 
partnership obtained 3 separate nonrecourse loans that were ``cross-
collateralized'' (i.e., if each separate loan were secured by all 3 of 
the apartment buildings).
    (ii) Netting of increases and decreases in partnership minimum gain 
when there is a disposition. At the beginning of the partnership's 
fourth taxable year, the partnership (with the permission of the 
nonrecourse lender) disposes of Property A for $835,000 and uses a 
portion of the proceeds to repay $600,000 of the nonrecourse liability 
(the principal amount attributable to Property A), reducing the balance 
to $900,000. As a result of the disposition, the partnership realizes 
gain of $295,000 ($835,000 amount realized less $540,000 adjusted tax 
basis). If the disposition is viewed in isolation, the partnership has 
generated minimum gain of $60,000 on the sale of Property A ($600,000 of 
debt reduction less $540,000 adjusted tax basis). However, during the 
partnership's fourth taxable year it also generates rental income of 
$135,000, operating expenses of $30,000, interest expense of $105,000, 
and depreciation deductions of $90,000 ($45,000 on each remaining 
building). If the partnership were to dispose of the remaining two 
buildings in full satisfaction of its nonrecourse liability at the end 
of the partnership's fourth taxable year, it would realize gain of 
$180,000 ($900,000 amount realized less $720,000 aggregate adjusted tax 
basis), which is the amount of partnership minimum gain at the end of 
the year. Because the partnership minimum gain increased from $150,000 
to $180,000 during the partnership's fourth taxable year, the amount of 
partnership nonrecourse deductions for that year is $30,000, consisting 
of a ratable portion of depreciation deductions allowable with respect 
to the two remaining apartment buildings. No minimum gain chargeback is 
required for the taxable year, even though the partnership disposed of 
one of the properties subject to the nonrecourse liability during the 
year, because there is no net decrease in partnership minimum gain for 
the year. See paragraph (f)(1) of this section.
    Example 3. Nonrecourse deductions and partnership minimum gain 
before third partner is admitted. For purposes of Example 3, unless 
otherwise provided, the following facts are assumed. Additional facts 
are given in each of Examples 3 (ii), (iii), and (iv). A and B form a 
limited partnership to acquire and lease machinery that is 5-year 
recovery property. A, the limited partner, and B, the general partner, 
contribute $100,000 each to the partnership, which obtains an $800,000 
nonrecourse loan and purchases the machinery for $1,000,000. The 
nonrecourse loan is secured only by the machinery. The principal amount 
of the loan is to be repaid $50,000 per year during each of the 
partnership's first 5 taxable years, with the remaining $550,000 of 
unpaid principal due on the first day of the partnership's sixth taxable 
year. The partnership agreement contains all of the provisions required 
by paragraph (e) of this section, and, as of the end of each partnership 
taxable year discussed herein, the items described in Sec. 1.704-
1(b)(2)(ii)(d) (4), (5), and (6)

[[Page 362]]

are not reasonably expected to cause or increase a deficit balance in 
A's or B's capital account. The partnership agreement provides that, 
except as otherwise required by its qualified income offset and minimum 
gain chargeback provisions, all partnership items will be allocated 
equally between A and B. Finally, the partnership agreement provides 
that all distributions, other than distributions in liquidation of the 
partnership or of a partner's interest in the partnership, will be made 
equally between A and B. In the partnership's first taxable year it 
generates rental income of $130,000, interest expense of $80,000, and a 
depreciation deduction of $150,000, resulting in a net taxable loss of 
$100,000. In addition, the partnership repays $50,000 of the nonrecourse 
liability, reducing that liability to $750,000. Allocations of these 
losses equally between A and B have substantial economic effect.

------------------------------------------------------------------------
                                                       A           B    
------------------------------------------------------------------------
Capital account on formation....................   $100,000    $100,000 
    Less: net loss in year 1....................    (50,000)    (50,000)
                                                 -----------------------
Capital account at end of year 1................    $50,000     $50,000 
------------------------------------------------------------------------

In the partnership's second taxable year, it generates rental income of 
$130,000, interest expense of $75,000, and a depreciation deduction of 
$220,000, resulting in a net taxable loss of $165,000. In addition, the 
partnership repays $50,000 of the nonrecourse liability, reducing that 
liability to $700,000, and distributes $2,500 of cash to each partner. 
If the partnership were to dispose of the machinery in full satisfaction 
of the nonrecourse liability at the end of that year, it would realize 
$70,000 of gain ($700,000 amount realized less $630,000 adjusted tax 
basis). Therefore, the amount of partnership minimum gain at the end of 
that year (and the net increase in partnership minimum gain during the 
year) is $70,000, and the amount of partnership nonrecourse deductions 
for the year is $70,000. The partnership nonrecourse deductions for its 
second taxable year consist of $70,000 of the depreciation deductions 
allowable with respect to the machinery. Pursuant to the partnership 
agreement, all partnership items comprising the net taxable loss of 
$165,000, including the $70,000 nonrecourse deduction, are allocated 
equally between A and B. The allocation of these items, other than the 
nonrecourse deductions, has substantial economic effect.

------------------------------------------------------------------------
                                                        A          B    
------------------------------------------------------------------------
Capital account at end of year 1..................   $50,000    $50,000 
    Less: net loss in year 2 (without nonrecourse                       
     deductions)..................................   (47,500)   (47,500)
    Less: nonrecourse deductions in year 2........   (35,000)   (35,000)
    Less: distribution............................    (2,500)    (2,500)
                                                   ---------------------
Capital account at end of year 2..................  ($35,000)  ($35,000)
------------------------------------------------------------------------

    (i) Calculation of nonrecourse deductions and partnership minimum 
gain. Because all of the requirements of paragraph (e) of this section 
are satisfied, the allocation of nonrecourse deductions is deemed to be 
made in accordance with the partners' interests in the partnership. At 
the end of the partnership's second taxable year, A's and B's shares of 
partnership minimum gain are $35,000 each. Therefore, pursuant to 
paragraph (g)(1) of this section, A and B are treated as obligated to 
restore deficit balances in their capital accounts of $35,000 each. If 
the partnership were to dispose of the machinery in full satisfaction of 
the nonrecourse liability at the beginning of the partnership's third 
taxable year (and had no other economic activity in that year), the 
partnership minimum gain would be decreased from $70,000 to zero. A's 
and B's shares of that net decrease would be $35,000 each. Upon that 
disposition, the minimum gain chargeback would require that A and B each 
be allocated $35,000 of that gain before any other allocation is made 
under section 704 (b) with respect to partnership items for the 
partnership's third taxable year.
    (ii) Nonrecourse deductions and restatement of capital accounts. (a) 
Additional facts. C is admitted to the partnership at the beginning of 
the partnership's third taxable year. At the time of C's admission, the 
fair market value of the machinery is $900,000. C contributes $100,000 
to the partnership (the partnership invests $95,000 of this in 
undeveloped land and holds the other $5,000 in cash) in exchange for an 
interest in the partnership. In connection with C's admission to the 
partnership, the partnership's machinery is revalued on the 
partnership's books to reflect its fair market value of $900,000. 
Pursuant to Sec. 1.704-1(b)(2)(iv)(f), the capital accounts of A and B 
are adjusted upwards to $100,000 each to reflect the revaluation of the 
partnership's machinery. This adjustment reflects the manner in which 
the partnership gain of $270,000 ($900,000 fair market value minus 
$630,000 adjusted tax basis) would be shared if the machinery were sold 
for its fair market value immediately prior to C's admission to the 
partnership.

------------------------------------------------------------------------
                                                       A           B    
------------------------------------------------------------------------
Capital account before C's admission............   ($35,000)   ($35,000)
    Deemed sale adjustment......................    135,000     135,000 
                                                 -----------------------
Capital account adjusted for C's admission......   $100,000    $100,000 
------------------------------------------------------------------------


[[Page 363]]

The partnership agreement is modified to provide that, except as 
otherwise required by its qualified income offset and minimum gain 
chargeback provisions, partnership income, gain, loss, and deduction, as 
computed for book purposes, are allocated equally among the partners, 
and those allocations are reflected in the partners' capital accounts. 
The partnership agreement also is modified to provide that depreciation 
and gain or loss, as computed for tax purposes, with respect to the 
machinery will be shared among the partners in a manner that takes 
account of the variation between the property's $630,000 adjusted tax 
basis and its $900,000 book value, in accordance with Sec. 1.704-
1(b)(2)(iv)(f) and the special rule contained in Sec. 1.704-1(b)(4)(i).
    (b) Effect of revaluation. Because the requirements of Sec. 1.704-
1(b)(2)(iv)(g) are satisfied, the capital accounts of the partners (as 
adjusted) continue to be maintained in accordance with Sec. 1.704-
1(b)(2)(iv). If the partnership were to dispose of the machinery in full 
satisfaction of the nonrecourse liability immediately following the 
revaluation of the machinery, it would realize no book gain ($700,000 
amount realized less $900,000 book value). As a result of the 
revaluation of the machinery upward by $270,000, under part (i) of 
paragraph (d)(4) of this section, the partnership minimum gain is 
reduced from $70,000 immediately prior to the revaluation to zero; but 
under part (ii) of paragraph (d)(4) of this section, the partnership 
minimum gain is increased by the $70,000 decrease arising solely from 
the revaluation. Accordingly, there is no net increase or decrease 
solely on account of the revaluation, and so no minimum gain chargeback 
is triggered. All future nonrecourse deductions that occur will be the 
nonrecourse deductions as calculated for book purposes, and will be 
charged to all 3 partners in accordance with the partnership agreement. 
For purposes of determining the partners' shares of minimum gain under 
paragraph (g) of this section, A's and B's shares of the decrease 
resulting from the revaluation are $35,000 each. However, as illustrated 
below, under section 704(c) principles, the tax capital accounts of A 
and B will eventually be charged $35,000 each, reflecting their 50 
percent shares of the decrease in partnership minimum gain that resulted 
from the revaluation.
    (iii) Allocation of nonrecourse deductions following restatement of 
capital accounts. (a) Additional facts. During the partnership's third 
taxable year, the partnership generates rental income of $130,000, 
interest expense of $70,000 a tax depreciation deduction of $210,000, 
and a book depreciation deduction (attributable to the machinery) of 
$300,000. As a result, the partnership has a net taxable loss of 
$150,000 and a net book loss of $240,000. In addition, the partnership 
repays $50,000 of the nonrecourse liability (after the data of C's 
admission), reducing the liability to $650,000 and distributes $5,000 of 
cash to each partner.
    (b) Allocations. If the partnership were to dispose of the machinery 
in full satisfaction of the nonrecourse liability at the end of the 
year, $50,000 of book gain would result ($650,000 amount realized less 
$600,000 book basis). Therefore, the amount of partnership minimum gain 
at the end of the year is $50,000, which represents a net decrease in 
partnership minimum gain of $20,000 during the year. (This is so even 
though there would be an increase in partnership minimum gain in the 
partnership's third taxable year if minimum gain were computed with 
reference to the adjusted tax basis of the machinery.) Nevertheless, 
pursuant to paragraph (d)(4) of this section, the amount of nonrecourse 
deductions of the partnership for its third taxable year is $50,000 (the 
net increase in partnership minimum gain during the year determined by 
adding back the $70,000 decrease in partnership minimum gain 
attributable to the revaluation of the machinery to the $20,000 net 
decrease in partnership minimum gain during the year). The $50,000 of 
partnership nonrecourse deductions for the year consist of book 
depreciation deductions allowable with respect to the machinery of 
$50,000. Pursuant to the partnership agreement, all partnership items 
comprising the net book loss of $240,000, including the $50,000 
nonrecourse deduction, are allocated equally among the partners. The 
allocation of these items, other than the nonrecourse deductions, has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in Sec. 1.704-1(b)(4)(i), 
the partnership agreement provides that the depreciation deduction for 
tax purposes of $210,000 for the partnership's third taxable year is, in 
accordance with section 704(c) principles, shared $55,000 to A, $55,000 
to B, and $100,000 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C           
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book   
----------------------------------------------------------------------------------------------------------------
Capital account at beginning of                                                                                 
 year 3...........................    ($35,000)    $100,000     ($35,000)   $100,0000     $100,000     $100,000 
Less: nonrecourse deductions......      (9,166)     (16,666)      (9,166)     (16,666)     (16,666)     (16,666)
Less: items other than nonrecourse                                                                              
 deductions in year 3.............     (25,834)     (63,334)     (25,834)     (63,334)     (63,334)     (63,334)
Less: distribution................      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)
                                   -----------------------------------------------------------------------------

[[Page 364]]

                                                                                                                
Capital account at end of year 3..    ($75,000)     $15,000     ($75,000)     $15,000      $15,000      $15,000 
----------------------------------------------------------------------------------------------------------------

Because the requirements of paragraph (e) of this section are satisfied, 
the allocation of the nonrecourse deduction is deemed to be made in 
accordance with the partners' interests in the partnership. At the end 
of the partnership's third taxable year, A's, B's, and C's shares of 
partnership minimum gain are $16,666 each.
    (iv) Subsequent allocation of nonrecourse deductions following 
restatement of capital accounts. (a) Additional facts. The partners' 
capital accounts at the end of the second and third taxable years of the 
partnership are as stated in Example 3(iii) of this paragraph (m). In 
addition, during the partnership's fourth taxable year the partnership 
generates rental income of $130,000, interest expense of $65,000, a tax 
depreciation deduction of $210,000, and a book depreciation deduction 
(attributable to the machinery) of $300,000. As a result, the 
partnership has a net taxable loss of $145,000 and a net book loss of 
$235,000. In addition, the partnership repays $50,000 of the nonrecourse 
liability, reducing that liability to $600,000, and distributes $5,000 
of cash to each partner.
    (b) Allocations. If the partnership were to dispose of the machinery 
in full satisfaction of the nonrecourse liability at the end of the 
fourth year, $300,000 of book gain would result ($600,000 amount 
realized less $300,000 book value). Therefore, the amount of partnership 
minimum gain as of the end of the year is $300,000, which represents a 
net increase in partnership minimum gain during the year of $250,000. 
Thus, the amount of partnership nonrecourse deductions for that year 
equals $250,000, consisting of book depreciation deductions of $250,000. 
Pursuant to the partnership agreement, all partnership items comprising 
the net book loss of $235,000, including the $250,000 nonrecourse 
deduction, are allocated equally among the partners. That allocation of 
all items, other than the nonrecourse deductions, has substantial 
economic effect. Consistent with the special partners' interests in the 
partnership rule contained in Sec. 1.704-1(b)(4)(i), the partnership 
agreement provides that the depreciation deduction for tax purposes of 
$210,000 in the partnership's fourth taxable year is, in accordance with 
section 704(c) principles, allocated $55,000 to A, $55,000 to B, and 
$100,000 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C           
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book   
----------------------------------------------------------------------------------------------------------------
Capital account at end year 3.....    ($75,000)     $15,000     ($75,000)     $15,000      $15,000      $15,000 
Less: nonrecourse deductions......     (45,833)     (83,333)     (45,833)     (83,333)     (83,333)     (83,333)
Plus: items other than nonrecourse                                                                              
 deduction in year 4..............      12,499        5,000       12,499        5,000        5,000        5,000 
Less: distribution................      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)      (5,000)
                                   -----------------------------------------------------------------------------
Capital account at end of year 4..   ($113,334)    ($68,333)   ($113,333)    ($68,333)    ($68,333)    ($68,333)
----------------------------------------------------------------------------------------------------------------

The allocation of the $250,000 nonrecourse deduction equally among A, B, 
and C satisfies requirement (2) of paragraph (e) of this section. 
Because all of the requirements of paragraph (e) of this section are 
satisfied, the allocation is deemed to be in accordance with the 
partners' interests in the partnership. At the end of the partnership's 
fourth taxable year, A's, B's, and C's shares of partnership minimum 
gain are $100,000 each.
    (v) Disposition of partnership property following restatement of 
capital accounts. (a) Additional facts. The partners' capital accounts 
at the end of the fourth taxable year of the partnership are as stated 
above in (iv). In addition, at the beginning of the partnership's fifth 
taxable year it sells the machinery for $650,000 (using $600,000 of the 
proceeds to repay the nonrecourse liability), resulting in a taxable 
gain of $440,000 ($650,000 amount realized less $210,000 adjusted tax 
basis) and a book gain of $350,000 ($650,000 amount realized less 
$300,000 book basis). The partnership has no other items of income, 
gain, loss, or deduction for the year.
    (b) Effect of disposition. As a result of the sale, partnership 
minimum gain is reduced from $300,000 to zero, reducing A's, B's, and 
C's shares of partnership minimum gain to zero from $100,000 each. The 
minimum gain chargeback requires that A, B, and C each be allocated 
$100,000 of that gain (an amount equal to each partner's share of the 
net decrease in partnership minimum gain resulting from the sale) before 
any allocation is made to them under section 704(b) with respect to 
partnership items for the partnership's fifth taxable year. Thus, the 
allocation

[[Page 365]]

of the first $300,000 of book gain $100,000 to each of the partners is 
deemed to be in accordance with the partners' interests in the 
partnership under paragraph (e) of this section. The allocation of the 
remaining $50,000 of book gain equally among the partners has 
substantial economic effect. Consistent with the special partners' 
interests in the partnership rule contained in Sec. 1.704-1(b)(4)(i), 
the partnership agreement provides that the $440,000 taxable gain is, in 
accordance with section 704(c) principles, allocated $161,667 to A, 
$161,667 to B, and $116,666 to C.

----------------------------------------------------------------------------------------------------------------
                                                A                         B                         C           
                                   -----------------------------------------------------------------------------
                                        Tax          Book         Tax          Book         Tax          Book   
----------------------------------------------------------------------------------------------------------------
Capital account at end of year 4..   ($113,334)    ($68,333)   ($113,334)    ($68,333)    ($68,333)    ($68,333)
Plus: minimum gain chargeback.....     138,573      100,000      138,573      100,000      100,000      100,000 
Plus: additional gain.............      23,094       16,666       23,094       16,666       16,666       16,666 
                                   -----------------------------------------------------------------------------
Capital account before liquidation     $48,333      $48,333      $48,333      $48,333      $48,333      $48,333 
----------------------------------------------------------------------------------------------------------------

    Example 4. Allocations of increase in partnership minimum gain among 
partnership properties. For Example 4, unless otherwise provided, the 
following facts are assumed. A partnership owns 4 properties, each of 
which is subject to a nonrecourse liability of the partnership. During a 
taxable year of the partnership, the following events take place. First, 
the partnership generates a depreciation deduction (for both book and 
tax purposes) with respect to Property W of $10,000 and repays $5,000 of 
the nonrecourse liability secured only by that property, resulting in an 
increase in minimum gain with respect to that liability of $5,000. 
Second, the partnership generates a depreciation deduction (for both 
book and tax purposes) with respect to Property X of $10,000 and repays 
none of the nonrecourse liability secured by that property, resulting in 
an increase in minimum gain with respect to that liability of $10,000. 
Third, the partnership generates a depreciation deduction (for both book 
and tax purposes) of $2,000 with respect to Property Y and repays 
$11,000 of the nonrecourse liability secured only by that property, 
resulting in a decrease in minimum gain with respect to that liability 
of $9,000 (although at the end of that year, there remains minimum gain 
with respect to that liability). Finally, the partnership borrows $5,000 
on a nonrecourse basis, giving as the only security for that liability 
Property Z, a parcel of undeveloped land with an adjusted tax basis (and 
book value) of $2,000, resulting in a net increase in minimum gain with 
respect to that liability of $3,000.
    (i) Allocation of increase in partnership minimum gain. The net 
increase in partnership minimum gain during that partnership taxable 
year is $9,000, so that the amount of nonrecourse deductions of the 
partnership for that taxable year is $9,000. Those nonrecourse 
deductions consist of $3,000 of depreciation deductions with respect to 
Property W and $6,000 of depreciation deductions with respect to 
Property X. See paragraph (c) of this section. The amount of nonrecourse 
deductions consisting of depreciation deductions is determined as 
follows. With respect to the nonrecourse liability secured by Property 
Z, for which there is no depreciation deduction, the amount of 
depreciation deductions that constitutes nonrecourse deductions is zero. 
Similarly, with respect to the nonrecourse liability secured by Property 
Y, for which there is no increase in minimum gain, the amount of 
depreciation deductions that constitutes nonrecourse deductions is zero. 
With respect to each of the nonrecourse liabilities secured by 
Properties W and X, which are secured by property for which there are 
depreciation deductions and for which there is an increase in minimum 
gain, the amount of depreciation deductions that constitutes nonrecourse 
deductions is determined by the following formula:

net increase in the partnership minimum gain for that taxable year X 
total depreciation deductions for that taxable year on the specific 
property securing the nonrecourse liability to the extent minimum gain 
increased on that liability (divided by) total depreciation deductions 
for that taxable year on all properties securing nonrecourse liabilities 
to the extent of the aggregate increase in minimum gain on all those 
liabilities.

Thus, for the liability secured by Property W, the amount is $9,000 
times $5,000/$15,000, or $3,000. For the liability secured by Property 
X, the amount is $9,000 times $10,000/$15,000, or $6,000. (If one 
depreciable property secured two partnership nonrecourse liabilities, 
the amount of depreciation or book depreciation with respect to that 
property would be allocated among those liabilities in accordance with 
the method by which adjusted basis is allocated under paragraph (d)(2) 
of this section).
    (ii) Alternative allocation of increase in partnership minimum gain 
among partnership properties. Assume instead that the loan secured by 
Property Z is $15,000 (rather than $5,000), resulting in a net increase 
in minimum gain with respect to that liability of $13,000. Thus, the net 
increase in partnership minimum

[[Page 366]]

gain is $19,000, and the amount of nonrecourse deductions of the 
partnership for that taxable year is $19,000. Those nonrecourse 
deductions consist of $5,000 of depreciation deductions with respect to 
Property W, $10,000 of depreciation deductions with respect to Property 
X, and a pro rata portion of the partnership's other items of deduction, 
loss, and section 705(a)(2)(B) expenditure for that year. The method for 
computing the amounts of depreciation deductions that constitute 
nonrecourse deductions is the same as in (i) of this Example 4 for the 
liabilities secured by Properties Y and Z. With respect to each of the 
nonrecourse liabilities secured by Properties W and X, the amount of 
depreciation deductions that constitutes nonrecourse deductions equals 
the total depreciation deductions with respect to the partnership 
property securing that particular liability to the extent of the 
increase in minimum gain with respect to that liability.

[T.D. 8385, 56 FR 66983, Dec. 27, 1991; 57 FR 6073, Feb. 20, 1992; 57 FR 
8961, 8962, Mar. 13, 1992; 57 FR 11430, Apr. 3, 1992; 57 FR 28611, June 
26, 1992; 57 FR 37189, Aug. 18, 1992]



Sec. 1.704-3  Contributed property.

    (a) In general--(1) General principles. The purpose of section 
704(c) is to prevent the shifting of tax consequences among partners 
with respect to precontribution gain or loss. Under section 704(c), a 
partnership must allocate income, gain, loss, and deduction with respect 
to property contributed by a partner to the partnership so as to take 
into account any variation between the adjusted tax basis of the 
property and its fair market value at the time of contribution. 
Notwithstanding any other provision of this section, the allocations 
must be made using a reasonable method that is consistent with the 
purpose of section 704(c). For this purpose, an allocation method 
includes the application of all of the rules of this section (e.g., 
aggregation rules). An allocation method is not necessarily unreasonable 
merely because another allocation method would result in a higher 
aggregate tax liability. Paragraphs (b), (c), and (d) of this section 
describe allocation methods that are generally reasonable. Other methods 
may be reasonable in appropriate circumstances. Nevertheless, in the 
absence of specific published guidance, it is not reasonable to use an 
allocation method in which the basis of property contributed to the 
partnership is increased (or decreased) to reflect built-in gain (or 
loss), or a method under which the partnership creates tax allocations 
of income, gain, loss, or deduction independent of allocations affecting 
book capital accounts. See Sec. 1.704-3(d). Paragraph (e) of this 
section contains special rules and exceptions.
    (2) Operating rules. Except as provided in paragraphs (e)(2) and 
(e)(3) of this section, section 704(c) and this section apply on a 
property-by-property basis. Therefore, in determining whether there is a 
disparity between adjusted tax basis and fair market value, the built-in 
gains and built-in losses on items of contributed property cannot be 
aggregated. A partnership may use different methods with respect to 
different items of contributed property, provided that the partnership 
and the partners consistently apply a single reasonable method for each 
item of contributed property and that the overall method or combination 
of methods are reasonable based on the facts and circumstances and 
consistent with the purpose of section 704(c). It may be unreasonable to 
use one method for appreciated property and another method for 
depreciated property. Similarly, it may be unreasonable to use the 
traditional method for built-in gain property contributed by a partner 
with a high marginal tax rate while using curative allocations for 
built-in gain property contributed by a partner with a low marginal tax 
rate.
    (3) Definitions--(i) Section 704(c) property. Property contributed 
to a partnership is section 704(c) property if at the time of 
contribution its book value differs from the contributing partner's 
adjusted tax basis. For purposes of this section, book value is 
determined as contemplated by Sec. 1.704-1(b). Therefore, book value is 
equal to fair market value at the time of contribution and is 
subsequently adjusted for cost recovery and other events that affect the 
basis of the property. For a partnership that maintains capital accounts 
in accordance with Sec. 1.704-1(b)(2)(iv), the book value of property is 
initially the value used in determining the contributing partner's 
capital account under Sec. 1.704-1(b)(2)(iv)(d), and is appropriately 
adjusted thereafter (e.g., for book cost recovery under Secs. 1.704-
1(b)(2)(iv)(g)(3) and

[[Page 367]]

1.704-3(d)(2) and other events that affect the basis of the property). A 
partnership that does not maintain capital accounts under Sec. 1.704-
1(b)(2)(iv) must comply with this section using a book capital account 
based on the same principles (i.e., a book capital account that reflects 
the fair market value of property at the time of contribution and that 
is subsequently adjusted for cost recovery and other events that affect 
the basis of the property).
    (ii) Built-in gain and built-in loss. The built-in gain on section 
704(c) property is the excess of the property's book value over the 
contributing partner's adjusted tax basis upon contribution. The built-
in gain is thereafter reduced by decreases in the difference between the 
property's book value and adjusted tax basis. The built-in loss on 
section 704(c) property is the excess of the contributing partner's 
adjusted tax basis over the property's book value upon contribution. The 
built-in loss is thereafter reduced by decreases in the difference 
between the property's adjusted tax basis and book value.
    (4) Accounts payable and other accrued but unpaid items. Accounts 
payable and other accrued but unpaid items contributed by a partner 
using the cash receipts and disbursements method of accounting are 
treated as section 704(c) property for purposes of applying the rules of 
this section.
    (5) Other provisions of the Internal Revenue Code. Section 704(c) 
and this section apply to a contribution of property to the partnership 
only if the contribution is governed by section 721, taking into account 
other provisions of the Internal Revenue Code. For example, to the 
extent that a transfer of property to a partnership is a sale under 
section 707, the transfer is not a contribution of property to which 
section 704(c) applies.
    (6) Other applications of section 704(c) principles--(i) 
Revaluations under section 704(b). The principles of this section apply 
to allocations with respect to property for which differences between 
book value and adjusted tax basis are created when a partnership 
revalues partnership property pursuant to Sec. 1.704-1(b)(2)(iv)(f) 
(reverse section 704(c) allocations). Partnerships are not required to 
use the same allocation method for reverse section 704(c) allocations as 
for contributed property, even if at the time of revaluation the 
property is already subject to section 704(c) and paragraph (a) of this 
section. In addition, partnerships are not required to use the same 
allocation method for reverse section 704(c) allocations each time the 
partnership revalues its property. A partnership that makes allocations 
with respect to revalued property must use a reasonable method that is 
consistent with the purposes of section 704(b) and (c).
    (ii) Basis adjustments. A partnership making adjustments under 
Sec. 1.743-1(b) or 1.751-1(a)(2) must account for built-in gain or loss 
under section 704(c) in accordance with the principles of this section.
    (7) Transfers of a partnership interest. If a contributing partner 
transfers a partnership interest, built-in gain or loss must be 
allocated to the transferee partner as it would have been allocated to 
the transferor partner. If the contributing partner transfers a portion 
of the partnership interest, the share of built-in gain or loss 
proportionate to the interest transferred must be allocated to the 
transferee partner.
    (8) Disposition of property in nonrecognition transaction. If a 
partnership disposes of section 704(c) property in a nonrecognition 
transaction in which no gain or loss is recognized, the substituted 
basis property (within the meaning of section 7701(a)(42)) is treated as 
section 704(c) property with the same amount of built-in gain or loss as 
the section 704(c) property disposed of by the partnership. If gain or 
loss is recognized in such a transaction, appropriate adjustments must 
be made. The allocation method for the substituted basis property must 
be consistent with the allocation method chosen for the original 
property. If a partnership transfers an item of section 704(c) property 
together with other property to a corporation under section 351, in 
order to preserve that item's built-in gain or loss, the basis in the 
stock received in exchange for the section 704(c) property is determined 
as if each item of section 704(c) property had been the only property 
transferred to the corporation by the partnership.

[[Page 368]]

    (9) Tiered partnerships. If a partnership contributes section 704(c) 
property to a second partnership (the lower-tier partnership), or if a 
partner that has contributed section 704(c) property to a partnership 
contributes that partnership interest to a second partnership (the 
upper-tier partnership), the upper-tier partnership must allocate its 
distributive share of lower-tier partnership items with respect to that 
section 704(c) property in a manner that takes into account the 
contributing partner's remaining built-in gain or loss. Allocations made 
under this paragraph will be considered to be made in a manner that 
meets the requirements of Sec. 1.704-1(b)(2)(iv)(q) (relating to capital 
account adjustments where guidance is lacking).
    (10) Anti-abuse rule. An allocation method (or combination of 
methods) is not reasonable if the contribution of property (or event 
that results in reverse section 704(c) allocations) and the 
corresponding allocation of tax items with respect to the property are 
made with a view to shifting the tax consequences of built-in gain or 
loss among the partners in a manner that substantially reduces the 
present value of the partners' aggregate tax liability.
    (b) Traditional method--(1) In general. This paragraph (b) describes 
the traditional method of making section 704(c) allocations. In general, 
the traditional method requires that when the partnership has income, 
gain, loss, or deduction attributable to section 704(c) property, it 
must make appropriate allocations to the partners to avoid shifting the 
tax consequences of the built-in gain or loss. Under this rule, if the 
partnership sells section 704(c) property and recognizes gain or loss, 
built-in gain or loss on the property is allocated to the contributing 
partner. If the partnership sells a portion of, or an interest in, 
section 704(c) property, a proportionate part of the built-in gain or 
loss is allocated to the contributing partner. For section 704(c) 
property subject to amortization, depletion, depreciation, or other cost 
recovery, the allocation of deductions attributable to these items takes 
into account built-in gain or loss on the property. For example, tax 
allocations to the noncontributing partners of cost recovery deductions 
with respect to section 704(c) property generally must, to the extent 
possible, equal book allocations to those partners. However, the total 
income, gain, loss, or deduction allocated to the partners for a taxable 
year with respect to a property cannot exceed the total partnership 
income, gain, loss, or deduction with respect to that property for the 
taxable year (the ceiling rule). If a partnership has no property the 
allocations from which are limited by the ceiling rule, the traditional 
method is reasonable when used for all contributed property.
    (2) Examples. The following examples illustrate the principles of 
the traditional method.

    Example 1. Operation of the traditional method--(i) Calculation of 
built-in gain on contribution. A and B form partnership AB and agree 
that each will be allocated a 50 percent share of all partnership items 
and that AB will make allocations under section 704(c) using the 
traditional method under paragraph (b) of this section. A contributes 
depreciable property with an adjusted tax basis of $4,000 and a book 
value of $10,000, and B contributes $10,000 cash. Under paragraph (a)(3) 
of this section, A has built-in gain of $6,000, the excess of the 
partnership's book value for the property ($10,000) over A's adjusted 
tax basis in the property at the time of contribution ($4,000).
    (ii) Allocation of tax depreciation. The property is depreciated 
using the straight-line method over a 10-year recovery period. Because 
the property depreciates at an annual rate of 10 percent, B would have 
been entitled to a depreciation deduction of $500 per year for both book 
and tax purposes if the adjusted tax basis of the property equalled its 
fair market value at the time of contribution. Although each partner is 
allocated $500 of book depreciation per year, the partnership is allowed 
a tax depreciation deduction of only $400 per year (10 percent of 
$4,000). The partnership can allocate only $400 of tax depreciation 
under the ceiling rule of paragraph (b)(1) of this section, and it must 
be allocated entirely to B. In AB's first year, the proceeds generated 
by the equipment exactly equal AB's operating expenses. At the end of 
that year, the book value of the property is $9,000 ($10,000 less the 
$1,000 book depreciation deduction), and the adjusted tax basis is 
$3,600 ($4,000 less the $400 tax depreciation deduction). A's built-in 
gain with respect to the property decreases to $5,400 ($9,000 book value 
less $3,600 adjusted tax basis). Also, at the end of AB's first year, A 
has a $9,500 book capital account and a $4,000 tax basis in A's

[[Page 369]]

partnership interest. B has a $9,500 book capital account and a $9,600 
adjusted tax basis in B's partnership interest.
    (iii) Sale of the property. If AB sells the property at the 
beginning of AB's second year for $9,000, AB realizes tax gain of $5,400 
($9,000, the amount realized, less the adjusted tax basis of $3,600). 
Under paragraph (b)(1) of this section, the entire $5,400 gain must be 
allocated to A because the property A contributed has that much built-in 
gain remaining. If AB sells the property at the beginning of AB's second 
year for $10,000, AB realizes tax gain of $6,400 ($10,000, the amount 
realized, less the adjusted tax basis of $3,600). Under paragraph (b)(1) 
of this section, only $5,400 of gain must be allocated to A to account 
for A's built-in gain. The remaining $1,000 of gain is allocated equally 
between A and B in accordance with the partnership agreement. If AB 
sells the property for less than the $9,000 book value, AB realizes tax 
gain of less than $5,400, and the entire gain must be allocated to A.
    (iv) Termination and liquidation of partnership. If AB sells the 
property at the beginning of AB's second year for $9,000, and AB engages 
in no other transactions that year, A will recognize a gain of $5,400, 
and B will recognize no income or loss. A's adjusted tax basis for A's 
interest in AB will then be $9,400 ($4,000, A's original tax basis, 
increased by the gain of $5,400). B's adjusted tax basis for B's 
interest in AB will be $9,600 ($10,000, B's original tax basis, less the 
$400 depreciation deduction in the first partnership year). If the 
partnership then terminates and distributes its assets ($19,000 in cash) 
to A and B in proportion to their capital account balances, A will 
recognize a capital gain of $100 ($9,500, the amount distributed to A, 
less $9,400, the adjusted tax basis of A's interest). B will recognize a 
capital loss of $100 (the excess of B's adjusted tax basis, $9,600, over 
the amount received, $9,500).
    Example 2. Unreasonable use of the traditional method--(i) Facts. C 
and D form partnership CD and agree that each will be allocated a 50 
percent share of all partnership items and that CD will make allocations 
under section 704(c) using the traditional method under paragraph (b) of 
this section. C contributes equipment with an adjusted tax basis of 
$1,000 and a book value of $10,000, with a view to taking advantage of 
the fact that the equipment has only one year remaining on its cost 
recovery schedule although its remaining economic life is significantly 
longer. At the time of contribution, C has a built-in gain of $9,000 and 
the equipment is section 704(c) property. D contributes $10,000 of cash, 
which CD uses to buy securities. D has substantial net operating loss 
carryforwards that D anticipates will otherwise expire unused. Under 
Sec. 1.704-1(b)(2)(iv)(g)(3), the partnership must allocate the $10,000 
of book depreciation to the partners in the first year of the 
partnership. Thus, there is $10,000 of book depreciation and $1,000 of 
tax depreciation in the partnership's first year. CD sells the equipment 
during the second year for $10,000 and recognizes a $10,000 gain 
($10,000, the amount realized, less the adjusted tax basis of $0).
    (ii) Unreasonable use of method--(A) At the beginning of the second 
year, both the book value and adjusted tax basis of the equipment are 
$0. Therefore, there is no remaining built-in gain. The $10,000 gain on 
the sale of the equipment in the second year is allocated $5,000 each to 
C and D. The interaction of the partnership's one-year write-off of the 
entire book value of the equipment and the use of the traditional method 
results in a shift of $4,000 of the precontribution gain in the 
equipment from C to D (D's $5,000 share of CD's $10,000 gain, less the 
$1,000 tax depreciation deduction previously allocated to D).
    (B) The traditional method is not reasonable under paragraph (a)(10) 
of this section because the contribution of property is made, and the 
traditional method is used, with a view to shifting a significant amount 
of taxable income to a partner with a low marginal tax rate and away 
from a partner with a high marginal tax rate.
    (C) Under these facts, if the partnership agreement in effect for 
the year of contribution had provided that tax gain from the sale of the 
property (if any) would always be allocated first to C to offset the 
effect of the ceiling rule limitation, the allocation method would not 
violate the anti-abuse rule of paragraph (a)(10) of this section. See 
paragraph (c)(3) of this section. Under other facts, (for example, if 
the partnership holds multiple section 704(c) properties and either uses 
multiple allocation methods or uses a single allocation method where one 
or more of the properties are subject to the ceiling rule) the 
allocation to C may not be reasonable.

    (c) Traditional method with curative allocations--(1) In general. To 
correct distortions created by the ceiling rule, a partnership using the 
traditional method under paragraph (b) of this section may make 
reasonable curative allocations to reduce or eliminate disparities 
between book and tax items of noncontributing partners. A curative 
allocation is an allocation of income, gain, loss, or deduction for tax 
purposes that differs from the partnership's allocation of the 
corresponding book item. For example, if a noncontributing partner is 
allocated less tax depreciation than book depreciation with respect to 
an item of section 704(c) property, the

[[Page 370]]

partnership may make a curative allocation to that partner of tax 
depreciation from another item of partnership property to make up the 
difference, notwithstanding that the corresponding book depreciation is 
allocated to the contributing partner. A partnership may limit its 
curative allocations to allocations of one or more particular tax items 
(e.g., only depreciation from a specific property or properties) even if 
the allocation of those available items does not offset fully the effect 
of the ceiling rule.
    (2) Consistency. A partnership must be consistent in its application 
of curative allocations with respect to each item of section 704(c) 
property from year to year.
    (3) Reasonable curative allocations--(i) Amount. A curative 
allocation is not reasonable to the extent it exceeds the amount 
necessary to offset the effect of the ceiling rule for the current 
taxable year or, in the case of a curative allocation upon disposition 
of the property, for prior taxable years.
    (ii) Timing. The period of time over which the curative allocations 
are made is a factor in determining whether the allocations are 
reasonable. Notwithstanding paragraph (c)(3)(i) of this section, a 
partnership may make curative allocations in a taxable year to offset 
the effect of the ceiling rule for a prior taxable year if those 
allocations are made over a reasonable period of time, such as over the 
property's economic life, and are provided for under the partnership 
agreement in effect for the year of contribution. See paragraph (c)(4) 
Example 3 (ii)(C) of this section.
    (iii) Type--(A) In general. To be reasonable, a curative allocation 
of income, gain, loss, or deduction must be expected to have 
substantially the same effect on each partner's tax liability as the tax 
item limited by the ceiling rule. The expectation must exist at the time 
the section 704(c) property is obligated to be (or is) contributed to 
the partnership and the allocation with respect to that property becomes 
part of the partnership agreement. However, the expectation is tested at 
the time the allocation with respect to that property is actually made 
if the partnership agreement is not sufficiently specific as to the 
precise manner in which allocations are to be made with respect to that 
property. Under this paragraph (c), if the item limited by the ceiling 
rule is loss from the sale of property, a curative allocation of gain 
must be expected to have substantially the same effect as would an 
allocation to that partner of gain with respect to the sale of the 
property. If the item limited by the ceiling rule is depreciation or 
other cost recovery, a curative allocation of income to the contributing 
partner must be expected to have substantially the same effect as would 
an allocation to that partner of partnership income with respect to the 
contributed property. For example, if depreciation deductions with 
respect to leased equipment contributed by a tax-exempt partner are 
limited by the ceiling rule, a curative allocation of dividend or 
interest income to that partner generally is not reasonable, although a 
curative allocation of depreciation deductions from other leased 
equipment to the noncontributing partner is reasonable. Similarly, under 
this rule, if depreciation deductions apportioned to foreign source 
income in a particular statutory grouping under section 904(d) are 
limited by the ceiling rule, a curative allocation of income from 
another statutory grouping to the contributing partner generally is not 
reasonable, although a curative allocation of income from the same 
statutory grouping and of the same character is reasonable.
    (B) Exception for allocation from disposition of contributed 
property. If cost recovery has been limited by the ceiling rule, the 
general limitation on character does not apply to income from the 
disposition of contributed property subject to the ceiling rule, but 
only if properly provided for in the partnership agreement in effect for 
the year of contribution or revaluation. For example, if allocations of 
depreciation deductions to a noncontributing partner have been limited 
by the ceiling rule, a curative allocation to the contributing partner 
of gain from the sale of that property, if properly provided for in the 
partnership agreement, is reasonable for purposes of paragraph 
(c)(3)(iii)(A) of this section even if not of the same character.

[[Page 371]]

    (4) Examples. The following examples illustrate the principles of 
this paragraph (c).

    Example 1. Reasonable and unreasonable curative allocations--(i) 
Facts. E and F form partnership EF and agree that each will be allocated 
a 50 percent share of all partnership items and that EF will make 
allocations under section 704(c) using the traditional method with 
curative allocations under paragraph (c) of this section. E contributes 
equipment with an adjusted tax basis of $4,000 and a book value of 
$10,000. The equipment has 10 years remaining on its cost recovery 
schedule and is depreciable using the straight-line method. At the time 
of contribution, E has a built-in gain of $6,000, and therefore, the 
equipment is section 704(c) property. F contributes $10,000 of cash, 
which EF uses to buy inventory for resale. In EF's first year, the 
revenue generated by the equipment equals EF's operating expenses. The 
equipment generates $1,000 of book depreciation and $400 of tax 
depreciation for each of 10 years. At the end of the first year EF sells 
all the inventory for $10,700, recognizing $700 of income. The partners 
anticipate that the inventory income will have substantially the same 
effect on their tax liabilities as income from E's contributed 
equipment. Under the traditional method of paragraph (b) of this 
section, E and F would each be allocated $350 of income from the sale of 
inventory for book and tax purposes and $500 of depreciation for book 
purposes. The $400 of tax depreciation would all be allocated to F. 
Thus, at the end of the first year, E and F's book and tax capital 
accounts would be as follows:

----------------------------------------------------------------------------------------------------------------
               E                               F                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $4,000         $10,000         $10,000  Initial contribution.                           
<500>.........             <0>           <500>           <400>  Depreciation.                                   
350...........             350             350             350  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,850.........           4,350           9,850           9,950                                                  
----------------------------------------------------------------------------------------------------------------

    (ii) Reasonable curative allocation. Because the ceiling rule would 
cause a disparity of $100 between F's book and tax capital accounts, EF 
may properly allocate to E under paragraph (c) of this section an 
additional $100 of income from the sale of inventory for tax purposes. 
This allocation results in capital accounts at the end of EF's first 
year as follows:

----------------------------------------------------------------------------------------------------------------
               E                               F                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $4,000         $10,000         $10,000  Initial contribution.                           
<500>.........             <0>           <500>           <400>  Depreciation.                                   
350...........             450             350             250  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,850.........           4,450           9,850           9,850                                                  
----------------------------------------------------------------------------------------------------------------

    (iii) Unreasonable curative allocation. (A) The facts are the same 
as in paragraphs (i) and (ii) of this Example 1, except that E and F 
choose to allocate all the income from the sale of the inventory to E 
for tax purposes, although they share it equally for book purposes. This 
allocation results in capital accounts at the end of EF's first year as 
follows:

----------------------------------------------------------------------------------------------------------------
               E                               F                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $4,000         $10,000         $10,000  Initial contribution.                           
<500>.........             <0>           <500>           <400>  Depreciation.                                   
350...........             700             350               0  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,850.........           4,700           9,850           9,600                                                  
----------------------------------------------------------------------------------------------------------------


[[Page 372]]

    (B) This curative allocation is not reasonable under paragraph 
(c)(3)(i) of this section because the allocation exceeds the amount 
necessary to offset the disparity caused by the ceiling rule.
    Example 2. Curative allocations limited to depreciation--(i) Facts. 
G and H form partnership GH and agree that each will be allocated a 50 
percent share of all partnership items and that GH will make allocations 
under section 704(c) using the traditional method with curative 
allocations under paragraph (c) of this section, but only to the extent 
that the partnership has sufficient tax depreciation deductions. G 
contributes property G1, with an adjusted tax basis of $3,000 and a fair 
market value of $10,000, and H contributes property H1, with an adjusted 
tax basis of $6,000 and a fair market value of $10,000. Both properties 
have 5 years remaining on their cost recovery schedules and are 
depreciable using the straight-line method. At the time of contribution, 
G1 has a built-in gain of $7,000 and H1 has a built-in gain of $4,000, 
and therefore, both properties are section 704(c) property. G1 generates 
$600 of tax depreciation and $2,000 of book depreciation for each of 
five years. H1 generates $1,200 of tax depreciation and $2,000 of book 
depreciation for each of 5 years. In addition, the properties each 
generate $500 of operating income annually. G and H are each allocated 
$1,000 of book depreciation for each property. Under the traditional 
method of paragraph (b) of this section, G would be allocated $0 of tax 
depreciation for G1 and $1,000 for H1, and H would be allocated $600 of 
tax depreciation for G1 and $200 for H1. Thus, at the end of the first 
year, G and H's book and tax capital accounts would be as follows:

----------------------------------------------------------------------------------------------------------------
               G                               H                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $3,000         $10,000          $6,000  Initial contribution.                           
<1,000>.......             <0>         <1,000>           <600>  G1 depreciation.                                
<1,000>.......         <1,000>         <1,000>           <200>  H1 depreciation.                                
500...........             500             500             500  Operating income.                               
                                                                                                                
---------------------------------------------------------------                                                 
8,500.........           2,500           8,500           5,700                                                  
----------------------------------------------------------------------------------------------------------------

    (ii) Curative allocations. Under the traditional method, G is 
allocated more depreciation deductions than H, even though H contributed 
property with a smaller disparity reflected on GH's book and tax capital 
accounts. GH makes curative allocations to H of an additional $400 of 
tax depreciation each year, which reduces the disparities between G and 
H's book and tax capital accounts ratably each year. These allocations 
are reasonable provided the allocations meet the other requirements of 
this section. As a result of their agreement, at the end of the first 
year, G and H's capital accounts are as follows:

----------------------------------------------------------------------------------------------------------------
               G                               H                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $3,000         $10,000          $6,000  Initial contribution.                           
<1,000>.......             <0>         <1,000>           <600>  G1 depreciation.                                
<1,000>.......           <600>         <1,000>           <600>  H1 depreciation.                                
500...........             500             500             500  Operating income.                               
                                                                                                                
---------------------------------------------------------------                                                 
8,500.........           2,900           8,500           5,300                                                  
----------------------------------------------------------------------------------------------------------------

    Example 3. Unreasonable use of curative allocations--(i) Facts. J 
and K form partnership JK and agree that each will receive a 50 percent 
share of all partnership items and that JK will make allocations under 
section 704(c) using the traditional method with curative allocations 
under paragraph (c) of this section. J contributes equipment with an 
adjusted tax basis of $1,000 and a book value of $10,000, with a view to 
taking advantage of the fact that the equipment has only one year 
remaining on its cost recovery schedule although it has an estimated 
remaining economic life of 10 years. J has substantial net operating 
loss carryforwards that J anticipates will otherwise expire unused. At 
the time of contribution, J has a built-in gain of $9,000, and 
therefore, the equipment is section 704(c) property. K contributes 
$10,000 of cash, which JK uses to buy inventory for resale. In JK's 
first year, the revenues generated by the equipment exactly equal JK's 
operating expenses. Under Sec. 1.704-1(b)(2)(iv)(g)(3), the partnership 
must allocate the $10,000 of book depreciation to the partners in the 
first year of the partnership. Thus, there is $10,000 of book 
depreciation

[[Page 373]]

and $1,000 of tax depreciation in the partnership's first year. In 
addition, at the end of the first year JK sells all of the inventory for 
$18,000, recognizing $8,000 of income. The partners anticipate that the 
inventory income will have substantially the same effect on their tax 
liabilities as income from J's contributed equipment. Under the 
traditional method of paragraph (b) of this section, J and K's book and 
tax capital accounts at the end of the first year would be as follows:

----------------------------------------------------------------------------------------------------------------
               J                               K                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $1,000         $10,000         $10,000  Initial contribution.                           
<5,000>.......             <0>         <5,000>         <1,000>  Depreciation.                                   
4,000.........           4,000           4,000           4,000  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,000.........           5,000           9,000          13,000                                                  
----------------------------------------------------------------------------------------------------------------

    (ii) Unreasonable use of method. (A) The use of curative allocations 
under these facts to offset immediately the full effect of the ceiling 
rule would result in the following book and tax capital accounts at the 
end of JK's first year:

----------------------------------------------------------------------------------------------------------------
               J                               K                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $1,000         $10,000         $10,000  Initial contribution.                           
<5,000>.......             <0>         <5,000>         <1,000>  Depreciation.                                   
4,000.........           8,000           4,000               0  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,000.........           9,000           9,000           9,000                                                  
----------------------------------------------------------------------------------------------------------------

    (B) This curative allocation is not reasonable under paragraph 
(a)(10) of this section because the contribution of property is made and 
the curative allocation method is used with a view to shifting a 
significant amount of partnership taxable income to a partner with a low 
marginal tax rate and away from a partner with a high marginal tax rate, 
within a period of time significantly shorter than the economic life of 
the property.
    (C) The property has only one year remaining on its cost recovery 
schedule even though its economic life is considerably longer. Under 
these facts, if the partnership agreement had provided for curative 
allocations over a reasonable period of time, such as over the 
property's economic life, rather than over its remaining cost recovery 
period, the allocations would have been reasonable. See paragraph 
(c)(3)(ii) of this section. Thus, in this example, JK would make a 
curative allocation of $400 of sales income to J in the partnership's 
first year (10 percent of $4,000). J and K's book and tax capital 
accounts at the end of the first year would be as follows:

----------------------------------------------------------------------------------------------------------------
               J                               K                                                                
---------------------------------------------------------------                                                 
     Book             Tax            Book             Tax                                                       
----------------------------------------------------------------------------------------------------------------
$10,000.......          $1,000         $10,000         $10,000  Initial contribution.                           
<5,000>.......             <0>         <5,000>         <1,000>  Depreciation.                                   
4,000.........           4,400           4,000           3,600  Sales income.                                   
                                                                                                                
---------------------------------------------------------------                                                 
9,000.........           5,400           9,000          12,600                                                  
----------------------------------------------------------------------------------------------------------------

    (d) Remedial allocation method--(1) In general. A partnership may 
adopt the remedial allocation method described in this paragraph to 
eliminate distortions caused by the ceiling rule. A partnership adopting 
the remedial allocation method eliminates those distortions by creating 
remedial items and allocating those items to its partners. Under the 
remedial allocation method, the partnership first determines the amount 
of book items under paragraph (d)(2) of this section and the partners' 
distributive shares of these items under section 704(b). The partnership 
then allocates the corresponding tax

[[Page 374]]

items recognized by the partnership, if any, using the traditional 
method described in paragraph (b)(1) of this section. If the ceiling 
rule (as defined in paragraph (b)(1) of this section) causes the book 
allocation of an item to a noncontributing partner to differ from the 
tax allocation of the same item to the noncontributing partner, the 
partnership creates a remedial item of income, gain, loss, or deduction 
equal to the full amount of the difference and allocates it to the 
noncontributing partner. The partnership simultaneously creates an 
offsetting remedial item in an identical amount and allocates it to the 
contributing partner.
    (2) Determining the amount of book items. Under the remedial 
allocation method, a partnership determines the amount of book items 
attributable to contributed property in the following manner rather than 
under the rules of Sec. 1.704-1(b)(2)(iv)(g)(3). The portion of the 
partnership's book basis in the property equal to the adjusted tax basis 
in the property at the time of contribution is recovered in the same 
manner as the adjusted tax basis in the property is recovered 
(generally, over the property's remaining recovery period under section 
168(i)(7) or other applicable Internal Revenue Code section). The 
remainder of the partnership's book basis in the property (the amount by 
which book basis exceeds adjusted tax basis) is recovered using any 
recovery period and depreciation (or other cost recovery) method 
(including first-year conventions) available to the partnership for 
newly purchased property (of the same type as the contributed property) 
that is placed in service at the time of contribution.
    (3) Type. Remedial allocations of income, gain, loss, or deduction 
to the noncontributing partner have the same tax attributes as the tax 
item limited by the ceiling rule. The tax attributes of offsetting 
remedial allocations of income, gain, loss, or deduction to the 
contributing partner are determined by reference to the item limited by 
the ceiling rule. Thus, for example, if the ceiling rule limited item is 
loss from the sale of contributed property, the offsetting remedial 
allocation to the contributing partner must be gain from the sale of 
that property. Conversely, if the ceiling rule limited item is gain from 
the sale of contributed property, the offsetting remedial allocation to 
the contributing partner must be loss from the sale of that property. If 
the ceiling rule limited item is depreciation or other cost recovery 
from the contributed property, the offsetting remedial allocation to the 
contributing partner must be income of the type produced (directly or 
indirectly) by that property. Any partner level tax attributes are 
determined at the partner level. For example, if the ceiling rule 
limited item is depreciation from property used in a rental activity, 
the remedial allocation to the noncontributing partner is depreciation 
from property used in a rental activity and the offsetting remedial 
allocation to the contributing partner is ordinary income from that 
rental activity. Each partner then applies section 469 to the 
allocations as appropriate.
    (4) Effect of remedial items--(i) Effect on partnership. Remedial 
items do not affect the partnership's computation of its taxable income 
under section 703 and do not affect the partnership's adjusted tax basis 
in partnership property.
    (ii) Effect on partners. Remedial items are notional tax items 
created by the partnership solely for tax purposes and do not affect the 
partners' book capital accounts. Remedial items have the same effect as 
actual tax items on a partner's tax liability and on the partner's 
adjusted tax basis in the partnership interest.
    (5) Limitations on use of methods involving remedial allocations--
(i) Limitation on taxpayers. In the absence of published guidance, the 
remedial allocation method described in this paragraph (d) is the only 
reasonable section 704(c) method permitting the creation of notional tax 
items.
    (ii) Limitation on Internal Revenue Service. In exercising its 
authority under paragraph (a)(10) of this section to make adjustments if 
a partnership's allocation method is not reasonable, the Internal 
Revenue Service will not require a partnership to use the remedial 
allocation method described in this paragraph (d) or any other method

[[Page 375]]

involving the creation of notional tax items.
    (6) Adjustments to application of method. The Commissioner may, by 
published guidance, prescribe adjustments to the remedial allocation 
method under this paragraph (d) as necessary or appropriate. This 
guidance may, for example, prescribe adjustments to the remedial 
allocation method to prevent the duplication or omission of items of 
income or deduction or to reflect more clearly the partners' income or 
the income of a transferee of a partner.

    (7) Examples. The following examples illustrate the principles of 
this paragraph (d).
    Example 1. Remedial allocation method--(i) Facts. On January 1, L 
and M form partnership LM and agree that each will be allocated a 50 
percent share of all partnership items. The partnership agreement 
provides that LM will make allocations under section 704(c) using the 
remedial allocation method under this paragraph (d) and that the 
straight-line method will be used to recover excess book basis. L 
contributes depreciable property with an adjusted tax basis of $4,000 
and a fair market value of $10,000. The property is depreciated using 
the straight-line method with a 10-year recovery period and has 4 years 
remaining on its recovery period. M contributes $10,000, which the 
partnership uses to purchase land. Except for the depreciation 
deductions, LM's expenses equal its income in each year of the 10 years 
commencing with the year the partnership is formed.
    (ii) Years 1 through 4. Under the remedial allocation method of this 
paragraph (d), LM has book depreciation for each of its first 4 years of 
$1,600 [$1,000 ($4,000 adjusted tax basis divided by the 4-year 
remaining recovery period) plus $600 ($6,000 excess of book value over 
tax basis, divided by the new 10-year recovery period)]. (For the 
purpose of simplifying the example, the partnership's book depreciation 
is determined without regard to any first-year depreciation 
conventions.) Under the partnership agreement, L and M are each 
allocated 50 percent ($800) of the book depreciation. M is allocated 
$800 of tax depreciation and L is allocated the remaining $200 of tax 
depreciation ($1,000-$800). See paragraph (d)(1) of this section. No 
remedial allocations are made because the ceiling rule does not result 
in a book allocation of depreciation to M different from the tax 
allocation. The allocations result in capital accounts at the end of 
LM's first 4 years as follows:

------------------------------------------------------------------------
                                        L                     M         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
Initial contribution........   $10,000     $4,000    $10,000    $10,000 
Depreciation................    <3,200>      <800>    <3,200>    <3,200>
                             -------------------------------------------
                                 $6,800     $3,200     $6,800     $6,800
------------------------------------------------------------------------

    (iii) Subsequent years. (A) For each of years 5 through 10, LM has 
$600 of book depreciation ($6,000 excess of initial book value over 
adjusted tax basis divided by the 10-year recovery period that commented 
in year 1), but no tax depreciation. Under the partnership agreement, 
the $600 of book depreciation is allocated equally to L and M. Because 
of the application of the ceiling rule in year 5, M would be allotted 
$300 of book depreciation, but no tax depreciation. Thus, at the end of 
LM's fifth year L's and M's book and tax capital accounts would be as 
follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    L                                           M                       
                                                                 ---------------------------------------------------------------------------------------
                                                                      Book               Tax                      Book                     Tax          
--------------------------------------------------------------------------------------------------------------------------------------------------------
End of year 4...................................................      $6,800                    $3,200                  $6,800                   $6,800 
Depreciation....................................................        <300>  .......................                    <300>  .......................
                                                                 ---------------------------------------------------------------------------------------
                                                                       $6,500                   $3,200                   $6,500                   $6,800
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (B) Because the ceiling rule would cause an annual disparity of $300 
between M's allocations of book and tax depreciation, LM must make 
remedial allocations of $300 of tax depreciation deductions to M under 
the remedial allocation method for each of years 5 through 10. LM must 
also make an offsetting remedial allocation to L of $300 of taxable 
income, which must be of the same type as income produced by the 
property. At the end of year 5, LM's capital accounts are as follows:

------------------------------------------------------------------------
                                        L                     M         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
End of year 4...............    $6,800     $3,200     $6,800     $6,800 
Depreciation................      <300>  .........      <300>  .........
Remedial allocations........  .........       300   .........      <300>
                             -------------------------------------------
                                $6,500     $3,500     $6,500     $6,500 
------------------------------------------------------------------------

    (C) At the end of year 10, LM's capital accounts are as follows:

[[Page 376]]



------------------------------------------------------------------------
                                        L                     M         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
End of year 5...............    $6,500     $3,500     $6,500     $6,500 
Depreciation................    <1,500>  .........    <1,500>  .........
Remedial allocations........  .........      1,500  .........    <1,500>
                             -------------------------------------------
                                $5,000      $5,000    $5,000     $5,000 
------------------------------------------------------------------------

    Example 2. Remedial allocations on sale--(i) Facts. N and P form 
partnership NP and agree that each will be allocated a 50 percent share 
of all partnership items. The partnership agreement provides that NP 
will make allocations under section 704(c) using the remedial allocation 
method under this paragraph (d). N contributes Blackacre (land) with an 
adjusted tax basis of $4,000 and a fair market value of $10,000. Because 
N has a built-in gain of $6,000, Blackacre is section 704(c) property. P 
contributes Whiteacre (land) with an adjusted tax basis and fair market 
value of $10,000. At the end of NP's first year, NP sells Blackacre to Q 
for $9,000 and recognizes a capital gain of $5,000 ($9,000 amount 
realized less $4,000 adjusted tax basis) and a book loss of $1,000 
($9,000 amount realized less $10,000 book basis). NP has no other items 
of income, gain, loss, or deduction. If the ceiling rule were applied, N 
would be allocated the entire $5,000 of tax gain and N and P would each 
be allocated $500 of book loss. Thus, at the end of NP's first year N's 
and P's book and tax capital accounts would be as follows:

------------------------------------------------------------------------
                                        N                     P         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
Initial contribution........   $10,000      $4,000   $10,000     $10,000
Sale of Blackacre...........      <500>      5,000      <500>  .........
                             -------------------------------------------
                                $9,500      $9,000     $9,500    $10,000
------------------------------------------------------------------------

    (ii) Remedial allocation. Because the ceiling rule would cause a 
disparity of $500 between P's allocation of book and tax loss, NP must 
make a remedial allocation of $500 of capital loss to P and an 
offsetting remedial allocation to N of an additional $500 of capital 
gain. These allocations result in capital accounts at the end of NP's 
first year as follows:

------------------------------------------------------------------------
                                        N                     P         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
Initial contribution........   $10,000      $4,000   $10,000     $10,000
Sale of Blackacre...........      <500>      5,000      <500>  .........
Remedial allocations........  .........        500  .........      <500>
                             -------------------------------------------
                                $9,500      $9,500    $9,500     $9,500 
------------------------------------------------------------------------

    Example 3. Remedial allocation where built-in gain property sold for 
book and tax loss--(i) Facts. The facts are the same as in Example 2, 
except that at the end of NP's first year, NP sells Blackacre to Q for 
$3,000 and recognizes a capital loss of $1,000 ($3,000 amount realized 
less $4,000 adjusted tax basis) and a book loss of $7,000 ($3,000 amount 
realized less $10,000 book basis). If the ceiling rule were applied, P 
would be allocated the entire $1,000 of tax loss and N and P would each 
be allocated $3,500 of book loss. Thus, at the end of NP's first year, 
N's and P's book and tax capital accounts would be as follows:

------------------------------------------------------------------------
                                        N                     P         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
Initial contribution........   $10,000      $4,000   $10,000    $10,000 
Sale of Blackacre...........    <3,500>          0    <3,500>    <1,000>
                             -------------------------------------------
                                $6,500      $4,000    $6,500     $9,000 
------------------------------------------------------------------------

    (ii) Remedial allocation. Because the ceiling rule would cause a 
disparity of $2,500 between P's allocation of book and tax loss on the 
sale of Blackacre, NP must make a remedial allocation of $2,500 of 
capital loss to P and an offsetting remedial allocation to N of $2,500 
of capital gain. These allocations result in capital accounts at the end 
of NP's first year as follows:

------------------------------------------------------------------------
                                        N                     P         
                             -------------------------------------------
                                 Book       Tax        Book       Tax   
------------------------------------------------------------------------
Initial contribution........   $10,000      $4,000   $10,000    $10,000 
Sale of Blackacre...........    <3,500>          0    <3,500>    <1,000>
Remedial Allocations........  .........      2,500  .........    <2,500>
                             -------------------------------------------
                                $6,500      $6,500    $6,500     $6,500 
------------------------------------------------------------------------

    (e) Exceptions and special rules--(1) Small disparities--(i) General 
rule. If a partner contributes one or more items of property to a 
partnership within a single taxable year of the partnership, and the 
disparity between the book value of the property and the contributing 
partner's adjusted tax basis in the property is a small disparity, the 
partnership may--
    (A) Use a reasonable section 704(c) method;

[[Page 377]]

    (B) Disregard the application of section 704(c) to the property; or
    (C) Defer the application of section 704(c) to the property until 
the disposition of the property.
    (ii) Definition of small disparity. A disparity between book value 
and adjusted tax basis is a small disparity if the book value of all 
properties contributed by one partner during the partnership taxable 
year does not differ from the adjusted tax basis by more than 15 percent 
of the adjusted tax basis, and the total gross disparity does not exceed 
$20,000.
    (2) Aggregation. Each of the following types of property may be 
aggregated for purposes of making allocations under section 704(c) and 
this section if contributed by one partner during the partnership 
taxable year.
    (i) Depreciable property. All property, other than real property, 
that is included in the same general asset account of the contributing 
partner and the partnership under section 168.
    (ii) Zero-basis property. All property with a basis equal to zero, 
other than real property.
    (iii) Inventory. For partnerships that do not use a specific 
identification method of accounting, each item of inventory, other than 
qualified financial assets (as defined in paragraph (e)(3)(ii) of this 
section).
    (3) Special aggregation rule for securities partnerships--(i) 
General rule. For purposes of making reverse section 704(c) allocations, 
a securities partnership may aggregate gains and losses from qualified 
financial assets using any reasonable approach that is consistent with 
the purpose of section 704(c). Notwithstanding paragraphs (a)(2) and 
(a)(6)(i) of this section, once a partnership adopts an aggregate 
approach, that partnership must apply the same aggregate approach to all 
of its qualified financial assets for all taxable years in which the 
partnership qualifies as a securities partnership. Paragraphs (e)(3)(iv) 
and (e)(3)(v) of this section describe approaches for aggregating 
reverse section 704(c) gains and losses that are generally reasonable. 
Other approaches may be reasonable in appropriate circumstances. See, 
however, paragraph (a)(10) of this section, which describes the 
circumstances under which section 704(c) methods, including the 
aggregate approaches described in this paragraph (e)(3), are not 
reasonable. A partnership using an aggregate approach must separately 
account for any built-in gain or loss from contributed property.
    (ii) Qualified financial assets--(A) In general. A qualified 
financial asset is any personal property (including stock) that is 
actively traded. Actively traded means actively traded as defined in 
Sec. 1.1092(d)-1 (defining actively traded property for purposes of the 
straddle rules).
    (B) Management companies. For a management company, qualified 
financial assets also include the following, even if not actively 
traded: shares of stock in a corporation; notes, bonds, debentures, or 
other evidences of indebtedness; interest rate, currency, or equity 
notional principal contracts; evidences of an interest in, or derivative 
financial instruments in, any security, currency, or commodity, 
including any option, forward or futures contract, or short position; or 
any similar financial instrument.
    (C) Partnership interests. An interest in a partnership is not a 
qualified financial asset for purposes of this paragraph (e)(3)(ii). 
However, for purposes of this paragraph (e)(3), a partnership (upper-
tier partnership) that holds an interest in a securities partnership 
(lower-tier partnership) must take into account the lower-tier 
partnership's assets and qualified financial assets as follows:
    (1) In determining whether the upper-tier partnership qualifies as 
an investment partnership, the upper-tier partnership must treat its 
proportionate share of the lower-tier securities partnership's assets as 
assets of the upper-tier partnership; and
    (2) If the upper-tier partnership adopts an aggregate approach under 
this paragraph (e)(3), the upper-tier partnership must aggregate the 
gains and losses from its directly held qualified financial assets with 
its distributive share of the gains and losses from the qualified 
financial assets of the lower-tier securities partnership.
    (iii) Securities partnership--(A) In general. A partnership is a 
securities partnership if the partnership is either a

[[Page 378]]

management company or an investment partnership, and the partnership 
makes all of its book allocations in proportion to the partners' 
relative book capital accounts (except for reasonable special 
allocations to a partner that provides management services or investment 
advisory services to the partnership).
    (B) Definitions--(1) Management company. A partnership is a 
management company if it is registered with the Securities and Exchange 
Commission as a management company under the Investment Company Act of 
1940, as amended (15 U.S.C. 80a).
    (2) Investment partnership. A partnership is an investment 
partnership if:
    (i) On the date of each capital account restatement, the partnership 
holds qualified financial assets that constitute at least 90 percent of 
the fair market value of the partnership's non-cash assets; and
    (ii) The partnership reasonably expects, as of the end of the first 
taxable year in which the partnership adopts an aggregate approach under 
this paragraph (e)(3), to make revaluations at least annually.
    (iv) Partial netting approach. This paragraph (e)(3)(iv) describes 
the partial netting approach of making reverse section 704(c) 
allocations. See Example 1 of paragraph (e)(3)(ix) of this section for 
an illustration of the partial netting approach. To use the partial 
netting approach, the partnership must establish appropriate accounts 
for each partner for the purpose of taking into account each partner's 
share of the book gains and losses and determining each partner's share 
of the tax gains and losses. Under the partial netting approach, on the 
date of each capital account restatement, the partnership:
    (A) Nets its book gains and book losses from qualified financial 
assets since the last capital account restatement and allocates the net 
amount to its partners;
    (B) Separately aggregates all tax gains and all tax losses from 
qualified financial assets since the last capital account restatement; 
and
    (C) Separately allocates the aggregate tax gain and aggregate tax 
loss to the partners in a manner that reduces the disparity between the 
book capital account balances and the tax capital account balances 
(book-tax disparities) of the individual partners.
    (v) Full netting approach. This paragraph (e)(3)(v) describes the 
full netting approach of making reverse section 704(c) allocations on an 
aggregate basis. See Example 2 of paragraph (e)(3)(ix) of this section 
for an illustration of the full netting approach. To use the full 
netting approach, the partnership must establish appropriate accounts 
for each partner for the purpose of taking into account each partner's 
share of the book gains and losses and determining each partner's share 
of the tax gains and losses. Under the full netting approach, on the 
date of each capital account restatement, the partnership:
    (A) Nets its book gains and book losses from qualified financial 
assets since the last capital account restatement and allocates the net 
amount to its partners;
    (B) Nets tax gains and tax losses from qualified financial assets 
since the last capital account restatement; and
    (C) Allocates the net tax gain (or net tax loss) to the partners in 
a manner that reduces the book-tax disparities of the individual 
partners.
    (vi) Type of tax gain or loss. The character and other tax 
attributes of gain or loss allocated to the partners under this 
paragraph (e)(3) must:
    (A) Preserve the tax attributes of each item of gain or loss 
realized by the partnership;
    (B) Be determined under an approach that is consistently applied; 
and
    (C) Not be determined with a view to reducing substantially the 
present value of the partners' aggregate tax liability.
    (vii) Disqualified securities partnerships. A securities partnership 
that adopts an aggregate approach under this paragraph (e)(3) and 
subsequently fails to qualify as a securities partnership must make 
reverse section 704(c) allocations on an asset-by-asset basis after the 
date of disqualification. The partnership, however, is not required to 
disaggregate the book gain or book loss from qualified asset 
revaluations before the date of disqualification

[[Page 379]]

when making reverse section 704(c) allocations on or after the date of 
disqualification.
    (viii) Transitional rule for qualified financial assets revalued 
after effective date. A securities partnership revaluing its qualified 
financial assets pursuant to Sec. 1.704-1(b)(2)(iv)(f) on or after the 
effective date of this section may use any reasonable approach to 
coordinate with revaluations that occurred prior to the effective date 
of this section.
    (ix) Examples. The following examples illustrate the principles of 
this paragraph (e)(3).

    Example 1. Operation of the partial netting approach--(i) Facts. Two 
regulated investment companies, X and Y, each contribute $150,000 in 
cash to form PRS, a partnership that registers as a management company. 
The partnership agreement provides that book items will be allocated in 
accordance with the partners' relative book capital accounts, that book 
capital accounts will be adjusted to reflect daily revaluations of 
property pursuant to Sec. 1.704-1(b)(2)(iv)(f)(5)(iii), and that reverse 
section 704(c) allocations will be made using the partial netting 
approach described in paragraph (e)(3)(iv) of this section. X and Y each 
have an initial book capital account of $150,000. In addition, the 
partnership establishes for each of X and Y a revaluation account with a 
beginning balance of $0. On Day 1, PRS buys Stock 1, Stock 2, and Stock 
3 for $100,000 each. On Day 2, Stock 1 increases in value from $100,000 
to $102,000, Stock 2 increases in value from $100,000 to $105,000, and 
Stock 3 declines in value from $100,000 to $98,000. At the end of Day 2, 
Z, a regulated investment company, joins PRS by contributing $152,500 in 
cash for a one-third interest in the partnership [$152,500 divided by 
$300,000 (initial values of stock) +$5,000 (net gain at end of Day 2)+ 
$152,500]. PRS uses this cash to purchase Stock 4. PRS establishes a 
revaluation account for Z with a $0 beginning balance. As of the close 
of Day 3, Stock 1 increases in value from $102,000 to $105,000, and 
Stocks 2, 3, and 4 decrease in value from $105,000 to $102,000, from 
$98,000 to $96,000, and from $152,500 to $151,500, respectively. At the 
end of Day 3, PRS sells Stocks 2 and 3.
    (ii) Book allocations--Day 2. At the end of Day 2, PRS revalues the 
partnership's qualified financial assets and increases X's and Y's book 
capital accounts by each partner's 50 percent share of the $5,000 
($2,000 + $5,000 - $2,000) net increase in the value of the 
partnership's assets during Day 2. PRS increases X's and Y's respective 
revaluation account balances by $2,500 each to reflect the amount by 
which each partner's book capital account increased on Day 2. Z's 
capital account is not affected because Z did not join PRS until the end 
of Day 2. At the beginning of Day 3, the partnership's accounts are as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                      Stock 1    Stock 2    Stock 3     Stock 4 
----------------------------------------------------------------------------------------------------------------
Opening Balance....................................................   $100,000   $100,000   $100,000  ..........
Day 2 Adjustment...................................................      2,000      5,000    (2,000)  ..........
                                                                    --------------------------------------------
Total..............................................................   $102,000   $105,000   $98,000    $152,500 
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                                                       X                
                                      ----------------------------------
                                                             Revaluation
                                          Book       Tax       account  
------------------------------------------------------------------------
Opening Balance......................   $150,000   $150,000           0 
Day 2 Adjustment.....................      2,500          0      $2,500 
                                      ----------------------------------
Closing Balance......................   $152,500   $150,000      $2,500 
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                       Y                
                                      ----------------------------------
                                                             Revaluation
                                          Book       Tax       account  
------------------------------------------------------------------------
Opening Balance......................   $150,000   $150,000           0 
Day 2 Adjustment.....................      2,500          0      $2,500 
                                      ----------------------------------
Closing balance......................   $152,500   $150,000      $2,500 
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                       Z                
                                      ----------------------------------
                                                             Revaluation
                                          Book       Tax       account  
------------------------------------------------------------------------
Opening Balance......................  .........  .........  ...........
Day 2 Adjustment.....................  .........  .........  ...........
Closing Balance......................   $152,500   $152,500          $0 
------------------------------------------------------------------------

    (iii) Book and tax allocations--Day 3. At the end of Day 3, PRS 
decreases the book capital accounts of X, Y, and Z by $1,000 to reflect 
each partner's share of the $3,000 ($3,000--$3,000--$2,000--$1,000) net 
decrease in the value of the partnership's qualified financial assets. 
PRS also reduces each partner's revaluation account balance by $1,000. 
Accordingly, X's and Y's revaluation account balances are reduced to 
$1,500 each and Z's revaulation account balance is ($1,000). PRS then 
separately allocates the tax gain from the sale of Stock 2 and the tax 
loss from the sale of Stock 3. The $2,000 of tax gain recognized on the 
sale of Stock 2 ($102,000--$100,000) is allocated among the partners 
with positive revaluation account balances in accordance with the 
relative balances of those revaluation accounts. X's and Y's revaluation 
accounts have equal positive balances; thus, PRS allocates $1,000 of the 
gain from the sale of Stock 2 to X and $1,000 of that gain to Y. PRS 
allocates none of the gain from the sale to Z because Z's revaluation 
account balance is negative. The $4,000 of tax loss recognized from the 
sale of Stock

[[Page 380]]

3 ($96,000--$100,000) is allocated first to the partners with negative 
revaluation account balances to the extent of those balances. Because Z 
is the only partner with a negative revaluation account balance, the tax 
loss is allocated first to Z to the extent of Z's ($1,000) balance. The 
remaining $3,000 of tax loss is allocated among the partners in 
accordance with their distributive shares of the loss. Accordingly, PRS 
allocates $1,000 of tax loss from the sale of Stock 3 to each of X and 
Y. PRS also allocates an additional $1,000 of the tax loss to Z, so that 
Z's total share of the tax loss from the sale of Stock 3 is $2,000. PRS 
then reduces each partner's revaluation account balance by the amount of 
any tax gain allocated to that partner and increases each partner's 
revaluation account balance by the amount of any tax loss allocated to 
that partner. At the beginning of Day 4, the partnership's accounts are 
as follows:

----------------------------------------------------------------------------------------------------------------
                                                                   Stock 1     Stock 2     Stock 3     Stock 4  
----------------------------------------------------------------------------------------------------------------
Opening Balance.................................................   $100,000   $100,000    $100,000    $152,500  
Day 2 Adjustment................................................      2,000      5,000      (2,000)  ...........
Day 3 Adjustment................................................     $3,000     (3,000)     (2,000)      (1,000)
                                                                 -----------------------------------------------
Total...........................................................   $105,000   $102,000     $96,000    $151,500  
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                                                  X and Y               
                                  --------------------------------------
                                                             Revaluation
                                       Book         Tax        account  
------------------------------------------------------------------------
Opening Balance..................    $150,000     $150,000           0  
Day 2 Adjustment.................       2,500            0      $2,500  
Day 3 Adjustment.................      (1,000)           0     ($1,000) 
                                  --------------------------------------
Total............................    $151,500     $150,000      $1,500  
Gain from Stock 2................           0       $1,000      (1,000) 
Loss from Stock 3................           0      ($1,000)      1,000  
                                  --------------------------------------
Closing Balance..................    $151,500     $150,000      $1,500  
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                      Z                 
                                    ------------------------------------
                                                             Revaluation
                                        Book         Tax       account  
------------------------------------------------------------------------
Opening Balance....................   $152,500    $152,500            0 
Day 3 Adjustment...................     (1,000)          0      ($1,000)
                                    ------------------------------------
Total..............................   $151,500    $152,500      ($1,000)
Gain from Stock 2..................          0           0            0 
Loss from Stock 3..................          0      (2,000)       2,000 
                                    ------------------------------------
Closing Balance....................   $151,500    $150,500       $1,000 
------------------------------------------------------------------------

    Example 2. Operation of the full netting approach--(i) Facts. The 
facts are the same as in Example 1, except that the partnership 
agreement provides that PRS will make reverse section 704(c) allocations 
using the full netting approach described in paragraph (e)(3)(v) of this 
section.
    (ii) Book allocations--Days 2 and 3. PRS allocates its book gains 
and losses in the manner described in paragraphs (ii) and (iii) of 
Example 1 (the partial netting approach). Thus, at the end of Day 2, PRS 
increases the book capital accounts of X and Y by $2,500 to reflect the 
appreciation in the parntership's assets from the close of Day 1 to the 
close of Day 2 and records that increase in the revaluation account 
created for each partner. At the end of Day 3, PRS decreases the book 
capital accounts of X, Y, and Z by $1,000 to reflect each partner's 
share of the decline in value of the partnership's assets from Day 2 to 
Day 3 and reduces each partner's revaluation account by a corresponding 
amount.
    (iii) Tax allocations--Day 3. After making the book adjustments 
described in the previous paragraph, PRS allocates its net tax gain (or 
net tax loss) from its sales of qualified financial assets during Day 3. 
To do so, PRS first determines its net tax gain (or net tax loss) 
recognized from its sales of qualified financial assets for the day. 
There is a $2,000 net tax loss ($2,000 gain from the sale of Stock 2 
less $4,000 loss from the sale of Stock 3) on the sale of PRS's 
qualified financial assets. Because Z is the only partner with a 
negative revaluation account balance, the partnership's net tax loss is 
allocated first to Z to the extent of Z's ($1,000) revaluation account 
balance. The remaining net tax loss is allocated among the partners in 
accoradnce with their distributive shares of loss. Thus, PRS allocates 
$333.33 of the $2,000 net tax loss to each of X and Y. PRS also 
allocates an additional $333.33 of the net tax loss to Z, so that the 
total net tax loss allocation to Z is $1,333.33. PRS then increases each 
partner's revaluation account balance by the amount of net tax loss 
allocated to that partner. At the beginning of Day 4, the partnership's 
accounts are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Stock 1     Stock 2     Stock 3     Stock 4 
----------------------------------------------------------------------------------------------------------------
Opening Balance..................................................   $100,000   $100,000    $100,000    $152,500 
Day 2 Adjustment.................................................      2,000      5,000      (2,000)  ..........
Day 3 Adjustment.................................................      3,000     (3,000)     (2,000)    ($1,000)
                                                                  ----------------------------------------------
Total............................................................   $105,000   $102,000     $96,000    $151,500 
----------------------------------------------------------------------------------------------------------------


[[Page 381]]


------------------------------------------------------------------------
                                                  X and Y               
                                  --------------------------------------
                                                             Revaluation
                                       Book         Tax        account  
------------------------------------------------------------------------
Opening Balance..................    $150,000     $150,000           0  
Day 2 Adjustment.................      $2,500            0      $2,500  
Day 3 Adjustment.................      (1,000)           0      (1,000) 
                                  --------------------------------------
Total............................    $151,500     $150,000      $1,500  
Net Tax Loss-Stocks 2 & 3........           0         (333)        333  
                                  --------------------------------------
Closing Balance..................    $151,500     $149,667      $1,833  
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                      Z                 
                                    ------------------------------------
                                                             Revaluation
                                        Book         Tax       account  
------------------------------------------------------------------------
Opening Balance....................   $152,500    $152,500            0 
Day 3 Adjustment...................     (1,000)          0      ($1,000)
                                    ------------------------------------
    Total..........................   $151,500    $152,500      ($1,000)
Net Tax Loss-Stocks 2 & 3..........          0      (1,333)       1,333 
                                    ------------------------------------
Closing Balance....................   $151,500    $151,167         $333 
------------------------------------------------------------------------

    (4) Aggregation as permitted by the Commissioner. The Commissioner 
may, by published guidance or by letter ruling, permit:
    (i) Aggregation of properties other than those described in 
paragraphs (e)(2) and (e)(3) of this section;
    (ii) Partnerships and partners not described in paragraph (e)(3) of 
this section to aggregate gain and loss from qualified financial assets; 
and
    (iii) Aggregation of qualified financial assets for purposes of 
making section 704(c) allocations in the same manner as that described 
in paragraph (e)(3) of this section.
    (f) Effective date. This section applies to property contributed to 
a partnership and to restatements pursuant to Sec. 1.704-1(b)(2)(iv)(f) 
on or after December 21, 1993.

[T.D. 8500, 58 FR 67679, Dec. 22, 1993; 59 FR 4140, Jan. 28, 1994, as 
amended by T.D. 8585, 59 FR 66728, Dec. 28, 1994; 60 FR 11906, Mar. 3, 
1995]



Sec. 1.704-4  Distribution of contributed property.

    (a) Determination of gain and loss--(1) In general. A partner that 
contributes section 704(c) property to a partnership must recognize gain 
or loss under section 704(c)(1)(B) and this section on the distribution 
of such property to another partner within five years of its 
contribution to the partnership in an amount equal to the gain or loss 
that would have been allocated to such partner under section 
704(c)(1)(A) and Sec. 1.704-3 if the distributed property had been sold 
by the partnership to the distributee partner for its fair market value 
at the time of the distribution. See Sec. 1.704-3(a)(3)(i) for a 
definition of section 704(c) property.
    (2) Transactions to which section 704(c)(1)(B) applies. Section 
704(c)(1)(B) and this section apply only to the extent that a 
distribution by a partnership is a distribution to a partner acting in 
the capacity of a partner within the meaning of section 731.
    (3) Fair market value of property. The fair market value of the 
distributed section 704(c) property is the price at which the property 
would change hands between a willing buyer and a willing seller at the 
time of the distribution, neither being under any compulsion to buy or 
sell and both having reasonable knowledge of the relevant facts. The 
fair market value that a partnership assigns to distributed section 
704(c) property will be regarded as correct, provided that the value is 
reasonably agreed to among the partners in an arm's-length negotiation 
and the partners have sufficiently adverse interests.
    (4) Determination of five-year period--(i) General rule. The five-
year period specified in paragraph (a)(1) of this section begins on and 
includes the date of contribution.
    (ii) Section 708(b)(1)(B) terminations. A termination of the 
partnership under section 708(b)(1)(B) begins a new five-year period for 
each partner with respect to the built-in gain and built-in loss 
property that the partner is deemed to recontribute to a new partnership 
following the termination, but only to the extent that the pre-
termination built-in gain or loss, if any, on such property would not 
have been allocated to the contributing partner under section 
704(c)(1)(A) and Sec. 1.704-3 on a sale of the contributed property to 
an unrelated party immediately before the termination. See Sec. 1.704-
3(a)(3)(ii) for the definitions of built-in gain and built-in loss on 
section 704(c) property.
    (5) Examples. The following examples illustrate the rules of this 
paragraph

[[Page 382]]

(a). Unless otherwise specified, partnership income equals partnership 
expenses (other than depreciation deductions for contributed property) 
for each year of the partnership, the fair market value of partnership 
property does not change, all distributions by the partnership are 
subject to section 704(c)(1)(B), and all partners are unrelated.

    Example 1. Recognition of gain. (i) On January 1, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes $10,000 cash and 
Property A, nondepreciable real property with a fair market value of 
$10,000 and an adjusted tax basis of $4,000. Thus, there is a built-in 
gain of $6,000 on Property A at the time of contribution. B contributes 
$10,000 cash and Property B, nondepreciable real property with a fair 
market value and adjusted tax basis of $10,000. C contributes $20,000 
cash.
    (ii) On December 31, 1998, Property A and Property B are distributed 
to C in complete liquidation of C's interest in the partnership.
    (iii) A would have recognized $6,000 of gain under section 
704(c)(1)(A) and Sec. 1.704-3 on the sale of Property A at the time of 
the distribution ($10,000 fair market value less $4,000 adjusted tax 
basis). As a result, A must recognize $6,000 of gain on the distribution 
of Property A to C. B would not have recognized any gain or loss under 
section 704(c)(1)(A) and Sec. 1.704-3 on the sale of Property B at the 
time of distribution because Property B was not section 704(c) property. 
As a result, B does not recognize any gain or loss on the distribution 
of Property B.
    Example 2. Effect of post-contribution depreciation deductions. (i) 
On January 1, 1995, A, B, and C form partnership ABC as equal partners. 
A contributes Property A, depreciable property with a fair market value 
of $30,000 and an adjusted tax basis of $20,000. Therefore, there is a 
built-in gain of $10,000 on Property A. B and C each contribute $30,000 
cash. ABC uses the traditional method of making section 704(c) 
allocations described in Sec. 1.704-3(b) with respect to Property A.
    (ii) Property A is depreciated using the straight-line method over 
its remaining 10-year recovery period. The partnership has book 
depreciation of $3,000 per year (10 percent of the $30,000 book basis), 
and each partner is allocated $1,000 of book depreciation per year (one-
third of the total annual book depreciation of $3,000). The partnership 
has a tax depreciation deduction of $2,000 per year (10 percent of the 
$20,000 tax basis in Property A). This $2,000 tax depreciation deduction 
is allocated equally between B and C, the noncontributing partners with 
respect to Property A.
    (iii) At the end of the third year, the book value of Property A is 
$21,000 ($30,000 initial book value less $9,000 aggregate book 
depreciation) and the adjusted tax basis is $14,000 ($20,000 initial tax 
basis less $6,000 aggregate tax depreciation). A's remaining section 
704(c)(1)(A) built-in gain with respect to Property A is $7,000 ($21,000 
book value less $14,000 adjusted tax basis).
    (iv) On December 31, 1997, Property A is distributed to B in 
complete liquidation of B's interest in the partnership. If Property A 
had been sold for its fair market value at the time of the distribution, 
A would have recognized $7,000 of gain under section 704(c)(1)(A) and 
Sec. 1.704-3(b). Therefore, A recognizes $7,000 of gain on the 
distribution of Property A to B.
    Example 3. Effect of remedial method. (i) On January 1, 1995, A, B, 
and C form partnership ABC as equal partners. A contributes Property A1, 
nondepreciable real property with a fair market value of $10,000 and an 
adjusted tax basis of $5,000, and Property A2, nondepreciable real 
property with a fair market value and adjusted tax basis of $10,000. B 
and C each contribute $20,000 cash. ABC uses the remedial method of 
making section 704(c) allocations described in Sec. 1.704-3(d) with 
respect to Property A1.
    (ii) On December 31, 1998, when the fair market value of Property A1 
has decreased to $7,000, Property A1 is distributed to C in a current 
distribution. If Property A1 had been sold by the partnership at the 
time of the distribution, ABC would have recognized the $2,000 of 
remaining built-in gain under section 704(c)(1)(A) on the sale (fair 
market value of $7,000 less $5,000 adjusted tax basis). All of this gain 
would have been allocated to A. ABC would also have recognized a book 
loss of $3,000 ($10,000 original book value less $7,000 current fair 
market value of the property). Book loss in the amount of $2,000 would 
have been allocated equally between B and C. Under the remedial method, 
$2,000 of tax loss would also have been allocated equally to B and C to 
match their share of the book loss. As a result, $2,000 of gain would 
also have been allocated to A as an offsetting remedial allocation. A 
would have recognized $4,000 of total gain under section 704(c)(1)(A) on 
the sale of Property A1 ($2,000 of section 704(c) recognized gain plus 
$2,000 remedial gain). Therefore, A recognizes $4,000 of gain on the 
distribution of Property A1 to C under this section.

    (b) Character of gain or loss--(1) General rule. Gain or loss 
recognized by the contributing partner under section 704(c)(1)(B) and 
this section has the same character as the gain or loss that would have 
resulted if the distributed property had been sold by the partnership to 
the distributee partner at the time of the distribution.

[[Page 383]]

    (2) Example. The following example illustrates the rule of this 
paragraph (b). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Character of gain. (i) On January 1, 1995, A and B form 
partnership AB. A contributes $10,000 and Property A, nondepreciable 
real property with a fair market value of $10,000 and an adjusted tax 
basis of $4,000, in exchange for a 25 percent interest in partnership 
capital and profits. B contributes $60,000 cash for a 75 percent 
interest in partnership capital and profits.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution. Property A is used in a trade or business of B.
    (iii) A would have recognized $6,000 of gain under section 
704(c)(1)(A) on a sale of Property A at the time of the distribution 
(the difference between the fair market value ($10,000) and the adjusted 
tax basis ($4,000) of the property at that time). Because Property A is 
not a capital asset in the hands of Partner B and B holds more than 50 
percent of partnership capital and profits, the character of the gain on 
a sale of Property A to B would have been ordinary income under section 
707(b)(2). Therefore, the character of the gain to A on the distribution 
of Property A to B is ordinary income.

    (c) Exceptions--(1) Property contributed on or before October 3, 
1989. Section 704(c)(1)(B) and this section do not apply to property 
contributed to the partnership on or before October 3, 1989.
    (2) Certain liquidations. Section 704(c)(1)(B) and this section do 
not apply to a distribution of an interest in section 704(c) property to 
a partner other than the contributing partner in a liquidation of the 
partnership if--
    (i) The contributing partner receives an interest in the section 
704(c) property contributed by that partner (and no other property); and
    (ii) The built-in gain or loss in the interest distributed to the 
contributing partner, determined immediately after the distribution, is 
equal to or greater than the built-in gain or loss on the property that 
would have been allocated to the contributing partner under section 
704(c)(1)(A) and Sec. 1.704-3 on a sale of the contributed property to 
an unrelated party immediately before the distribution.
    (3) Section 708(b)(1)(B) termination. Section 704(c)(1)(B) and this 
section do not apply to a deemed distribution of property caused by a 
termination of the partnership under section 708(b)(1)(B). See paragraph 
(a)(4)(ii) of this section for a special rule regarding a new five-year 
period for certain property deemed contributed to a new partnership 
following a termination of the partnership under section 708(b)(1)(B). 
See also Sec. 1.737-2(a) for a similar rule in the context of section 
737.
    (4) Complete transfer to another partnership. Section 704(c)(1)(B) 
and this section do not apply to a transfer by a partnership (transferor 
partnership) of all of its assets and liabilities to a second 
partnership (transferee partnership) in an exchange described in section 
721, followed by a distribution of the interest in the transferee 
partnership in liquidation of the transferor partnership as part of the 
same plan or arrangement. A subsequent distribution of section 704(c) 
property by the transferee partnership to a partner of the transferee 
partnership is subject to section 704(c)(1)(B) to the same extent that a 
distribution by the transferor partnership would have been subject to 
section 704(c)(1)(B). See Sec. 1.737-2(b) for a similar rule in the 
context of section 737.
    (5) Incorporation of a partnership. Section 704(c)(1)(B) and this 
section do not apply to an incorporation of a partnership by any method 
of incorporation (other than a method involving an actual distribution 
of partnership property to the partners followed by a contribution of 
that property to a corporation), provided that the partnership is 
liquidated as part of the incorporation transaction. See Sec. 1.737-2(c) 
for a similar rule in the context of section 737.
    (6) Undivided interests. Section 704(c)(1)(B) and this section do 
not apply to a distribution of an undivided interest in property to the 
extent that the undivided interest does not exceed the undivided 
interest, if any, contributed by the distributee partner in the same 
property. See Sec. 1.737-2(d)(4) for the application of section 737 in a 
similar

[[Page 384]]

context. The portion of the undivided interest in property retained by 
the partnership after the distribution, if any, that is treated as 
contributed by the distributee partner, is reduced to the extent of the 
undivided interest distributed to the distributee partner.
    (7) Example. The following example illustrates the rule of paragraph 
(c)(2) of this section. Unless otherwise specified, partnership income 
equals partnership expenses (other than depreciation deductions for 
contributed property) for each year of the partnership, the fair market 
value of partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. (i) On January 1, 1995, A and B form partnership AB, as 
equal partners. A contributes Property A, nondepreciable real property 
with a fair market value and adjusted tax basis of $20,000. B 
contributes Property B, nondepreciable real property with a fair market 
value of $20,000 and an adjusted tax basis of $10,000. Property B 
therefore has a built-in gain of $10,000 at the time of contribution.
    (ii) On December 31, 1998, the partnership liquidates when the fair 
market value of Property A has not changed, but the fair market value of 
Property B has increased to $40,000.
    (iii) In the liquidation, A receives Property A and a 25 percent 
interest in Property B. This interest in Property B has a fair market 
value of $10,000 to A, reflecting the fact that A was entitled to 50 
percent of the $20,000 post-contribution appreciation in Property B. The 
partnership distributes to B a 75 percent interest in Property B with a 
fair market value of $30,000. B's basis in this portion of Property B is 
$10,000 under section 732(b). As a result, B has a built-in gain of 
$20,000 in this portion of Property B immediately after the distribution 
($30,000 fair market value less $10,000 adjusted tax basis). This built-
in gain is greater than the $10,000 of built-in gain in Property B at 
the time of contribution to the partnership. B therefore does not 
recognize any gain on the distribution of a portion of Property B to A 
under this section.

    (d) Special rules--(1) Nonrecognition transactions. Property 
received by the partnership in exchange for section 704(c) property in a 
nonrecognition transaction is treated as the section 704(c) property for 
purposes of section 704(c)(1)(B) and this section to the extent that the 
property received is treated as section 704(c) property under 
Sec. 1.704-3(a)(8). See Sec. 1.737-2(d)(3) for a similar rule in the 
context of section 737.
    (2) Transfers of a partnership interest. The transferee of all or a 
portion of the partnership interest of a contributing partner is treated 
as the contributing partner for purposes of section 704(c)(1)(B) and 
this section to the extent of the share of built-in gain or loss 
allocated to the transferee partner. See Sec. 1.704-3(a)(7).
    (3) Distributions of like-kind property. If section 704(c) property 
is distributed to a partner other than the contributing partner and 
like-kind property (within the meaning of section 1031) is distributed 
to the contributing partner no later than the earlier of (i) 180 days 
following the date of the distribution to the non-contributing partner, 
or (ii) the due date (determined with regard to extensions) of the 
contributing partner's income tax return for the taxable year of the 
distribution to the noncontributing partner, the amount of gain or loss, 
if any, that the contributing partner would otherwise have recognized 
under section 704(c)(1)(B) and this section is reduced by the amount of 
built-in gain or loss in the distributed like-kind property in the hands 
of the contributing partner immediately after the distribution. The 
contributing partner's basis in the distributed like-kind property is 
determined as if the like-kind property were distributed in an unrelated 
distribution prior to the distribution of any other property distributed 
as part of the same distribution and is determined without regard to the 
increase in the contributing partner's adjusted tax basis in the 
partnership interest under section 704(c)(1)(B) and this section. See 
Sec. 1.707-3 for provisions treating the distribution of the like-kind 
property to the contributing partner as a disguised sale in certain 
situations.
    (4) Example. The following example illustrates the rules of this 
paragraph (d). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the

[[Page 385]]

partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Distribution of like-kind property. (i) On January 1, 1995, 
A, B, and C form partnership ABC as equal partners. A contributes 
Property A, nondepreciable real property with a fair market value of 
$20,000 and an adjusted tax basis of $10,000. B and C each contribute 
$20,000 cash. The partnership subsequently buys Property X, 
nondepreciable real property of a like-kind to Property A with a fair 
market value and adjusted tax basis of $8,000. The fair market value of 
Property X subsequently increases to $10,000.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution. At the same time, Property X is distributed to A 
in a current distribution. The distribution of Property X does not 
result in the contribution of Property A being properly characterized as 
a disguised sale to the partnership under Sec. 1.707-3. A's basis in 
Property X is $8,000 under section 732(a)(1). A therefore has $2,000 of 
built-in gain in Property X ($10,000 fair market value less $8,000 
adjusted tax basis).
    (iii) A would generally recognize $10,000 of gain under section 
704(c)(1)(B) on the distribution of Property A, the difference between 
the fair market value ($20,000) of the property and its adjusted tax 
basis ($10,000). This gain is reduced, however, by the amount of the 
built-in gain of Property X in the hands of A. As a result, A recognizes 
only $8,000 of gain on the distribution of Property A to B under section 
704(c)(1)(B) and this section.

    (e) Basis adjustments--(1) Contributing partner's basis in the 
partnership interest. The basis of the contributing partner's interest 
in the partnership is increased by the amount of the gain, or decreased 
by the amount of the loss, recognized by the partner under section 
704(c)(1)(B) and this section. This increase or decrease is taken into 
account in determining (i) the contributing partner's adjusted tax basis 
under section 732 for any property distributed to the partner in a 
distribution that is part of the same distribution as the distribution 
of the contributed property, other than like-kind property described in 
paragraph (d)(3) of this section (pertaining to the special rule for 
distributions of like-kind property), and (ii) the amount of the gain 
recognized by the contributing partner under section 731 or section 737, 
if any, on a distribution of money or property to the contributing 
partner that is part of the same distribution as the distribution of the 
contributed property. For a determination of basis in a distribution 
subject to section 737, see Sec. 1.737-3(a).
    (2) Partnership's basis in partnership property. The partnership's 
adjusted tax basis in the distributed section 704(c) property is 
increased or decreased immediately before the distribution by the amount 
of gain or loss recognized by the contributing partner under section 
704(c)(1)(B) and this section. Any increase or decrease in basis is 
therefore taken into account in determining the distributee partner's 
adjusted tax basis in the distributed property under section 732. For a 
determination of basis in a distribution subject to section 737, see 
Sec. 1.737-3(b).
    (3) Section 754 adjustments. The basis adjustments to partnership 
property made pursuant to paragraph (e)(2) of this section are not 
elective and must be made regardless of whether the partnership has an 
election in effect under section 754. Any adjustments to the bases of 
partnership property (including the distributed section 704(c) property) 
under section 734(b) pursuant to a section 754 election must be made 
after (and must take into account) the adjustments to basis made under 
paragraph (e)(2) of this section. See Sec. 1.737-3(c)(4) for a similar 
rule in the context of section 737.
    (4) Example. The following example illustrates the rules of this 
paragraph (e). Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example. Basis adjustment.  On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes $10,000 cash and 
Property A, nondepreciable real property with a fair market value of 
$10,000 and an adjusted tax basis of $4,000. B and C each contribute 
$20,000 cash.
    (ii) On December 31, 1998, Property A is distributed to B in a 
current distribution.
    (iii) Under paragraph (a) of this section, A recognizes $6,000 of 
gain on the distribution of Property A because that is the amount of

[[Page 386]]

gain that would have been allocated to A under section 704(c)(1)(A) and 
Sec. 1.704-3 on a sale of Property A for its fair market value at the 
time of the distribution (fair market value of Property A ($10,000) less 
its adjusted tax basis at the time of distribution ($4,000)). The 
adjusted tax basis of A's partnership interest is increased from $14,000 
to $20,000 to reflect this gain. The partnership's adjusted tax basis in 
Property A is increased from $4,000 to $10,000 immediately prior to its 
distribution to B. B's adjusted tax basis in Property A is therefore 
$10,000 under section 732(a)(1).

    (f) Anti-abuse rule--(1) In general. The rules of section 
704(c)(1)(B) and this section must be applied in a manner consistent 
with the purpose of section 704(c)(1)(B). Accordingly, if a principal 
purpose of a transaction is to achieve a tax result that is inconsistent 
with the purpose of section 704(c)(1)(B), the Commissioner can recast 
the transaction for federal tax purposes as appropriate to achieve tax 
results that are consistent with the purpose of section 704(c)(1)(B) and 
this section. Whether a tax result is inconsistent with the purpose of 
section 704(c)(1)(B) and this section must be determined based on all 
the facts and circumstances. See Sec. 1.737-4 for an anti-abuse rule and 
examples in the context of section 737.
    (2) Examples. The following examples illustrate the anti-abuse rule 
of this paragraph (f). The examples set forth below do not delineate the 
boundaries of either permissible or impermissible types of transactions. 
Further, the addition of any facts or circumstances that are not 
specifically set forth in an example (or the deletion of any facts or 
circumstances) may alter the outcome of the transaction described in the 
example. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 704(c)(1)(B), and all partners are 
unrelated.

    Example 1. Distribution in substance made within five-year period; 
results inconsistent with the purpose of section 704(c)(1)(B). (i) On 
January 1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $1,000. B and C each 
contributes $10,000 cash.
    (ii) On December 31, 1998, the partners desire to distribute 
Property A to B in complete liquidation of B's interest in the 
partnership. If Property A were distributed at that time, however, A 
would recognize $9,000 of gain under section 704(c)(1)(B), the 
difference between the $10,000 fair market value and the $1,000 adjusted 
tax basis of Property A, because Property A was contributed to the 
partnership less than five years before December 31, 1998. On becoming 
aware of this potential gain recognition, and with a principal purpose 
of avoiding such gain, the partners amend the partnership agreement on 
December 31, 1998, and take any other steps necessary to provide that 
substantially all of the economic risks and benefits of Property A are 
borne by B as of December 31, 1998, and that substantially all of the 
economic risks and benefits of all other partnership property are borne 
by A and C. The partnership holds Property A until January 5, 2000, at 
which time it is distributed to B in complete liquidation of B's 
interest in the partnership.
    (iii) The actual distribution of Property A occurred more than five 
years after the contribution of the property to the partnership. The 
steps taken by the partnership on December 31, 1998, however, are the 
functional equivalent of an actual distribution of Property A to B in 
complete liquidation of B's interest in the partnership as of that date. 
Section 704(c)(1)(B) requires recognition of gain when contributed 
section 704(c) property is in substance distributed to another partner 
within five years of its contribution to the partnership. Allowing a 
contributing partner to avoid section 704(c)(1)(B) through arrangements 
such as those in this Example 1 that have the effect of a distribution 
of property within five years of the date of its contribution to the 
partnership would effectively undermine the purpose of section 
704(c)(1)(B) and this section. As a result, the steps taken by the 
partnership on December 31, 1998, are treated as causing a distribution 
of Property A to B for purposes of section 704(c)(1)(B) on that date, 
and A recognizes gain of $9,000 under section 704(c)(1)(B) and this 
section at that time.
    (iv) Alternatively, if on becoming aware of the potential gain 
recognition to A on a distribution of Property A on December 31, 1998, 
the partners had instead agreed that B would continue as a partner with 
no changes to the partnership agreement or to B's economic interest in 
partnership operations, the distribution of Property A to B on January 
5, 2000, would not have been inconsistent with the purpose of section 
704(c)(1)(B) and this section. In that situation, Property A would not 
have been distributed until after the expiration of the five-year period 
specified in

[[Page 387]]

section 704(c)(1)(B) and this section. Deferring the distribution of 
Property A until the end of the five-year period for a principal purpose 
of avoiding the recognition of gain under section 704(c)(1)(B) and this 
section is not inconsistent with the purpose of section 704(c)(1)(B). 
Therefore, A would not have recognized gain on the distribution of 
Property A in that case.
    Example 2. Suspension of five-year period in manner consistent with 
the purpose of section 704(c)(1)(B). (i) A, B, and C form partnership 
ABC on January 1, 1995, to conduct bona fide business activities. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $1,000, in exchange for a 
49.5 percent interest in partnership capital and profits. B contributes 
$10,000 in cash for a 49.5 percent interest in partnership capital and 
profits. C contributes cash for a 1 percent interest in partnership 
capital and profits. A and B are wholly owned subsidiaries of the same 
affiliated group and continue to control the management of Property A by 
virtue of their controlling interests in the partnership. The 
partnership is formed pursuant to a plan a principal purpose of which is 
to minimize the period of time that A would have to remain a partner 
with a potential acquiror of Property A.
    (ii) On December 31, 1997, D is admitted as a partner to the 
partnership in exchange for $10,000 cash.
    (iii) On January 5, 2000, Property A is distributed to D in complete 
liquidation of D's interest in the partnership.
    (iv) The distribution of Property A to D occurred more than five 
years after the contribution of the property to the partnership. On 
these facts, however, a principal purpose of the transaction was to 
minimize the period of time that A would have to remain partners with a 
potential acquiror of Property A, and treating the five-year period of 
section 704(c)(1)(B) as running during a time when Property A was still 
effectively owned through the partnership by members of the contributing 
affiliated group of which A is a member is inconsistent with the purpose 
of section 704(c)(1)(B). Prior to the admission of D as a partner, the 
pooling of assets between A and B, on the one hand, and C, on the other 
hand, although sufficient to constitute ABC as a valid partnership for 
federal income tax purposes, is not a sufficient pooling of assets for 
purposes of running the five-year period with respect to the 
distribution of Property A to D. Allowing a contributing partner to 
avoid section 704(c)(1)(B) through arrangements such as those in this 
Example 2 would have the effect of substantially nullifying the five-
year requirement of section 704(c)(1)(B) and this section and elevating 
the form of the transaction over its substance. As a result, with 
respect to the distribution of Property A to D, the five-year period of 
section 704(c)(1)(B) is tolled until the admission of D as a partner on 
December 31, 1997. Therefore, the distribution of Property A occurred 
before the end of the five-year period of section 704(c)(1)(B), and A 
recognizes gain of $9,000 under section 704(c)(1)(B) on the 
distribution.

    (g) Effective date. This section applies to distributions by a 
partnership to a partner on or after January 9, 1995.

[T.D. 8642, 60 FR 66730, Dec. 26, 1995]



Sec. 1.705-1   Determination of basis of partner's interest.

    (a) General rule. (1) Section 705 and this section provide rules for 
determining the adjusted basis of a partner's interest in a partnership. 
A partner is required to determine the adjusted basis of his interest in 
a partnership only when necessary for the determination of his tax 
liability or that of any other person. The determination of the adjusted 
basis of a partnership interest is ordinarily made as of the end of a 
partnership taxable year. Thus, for example, such year-end determination 
is necessary in ascertaining the extent to which a partner's 
distributive share of partnership losses may be allowed. See section 
704(d). However, where there has been a sale or exchange of all or a 
part of a partnership interest or a liquidation of a partner's entire 
interest in a partnership, the adjusted basis of the partner's interest 
should be determined as of the date of sale or exchange or liquidation. 
The adjusted basis of a partner's interest in a partnership is 
determined without regard to any amount shown in the partnership books 
as the partner's ``capital'', ``equity'', or similar account. For 
example, A contributes property with an adjusted basis to him of $400 
(and a value of $1,000) to a partnership. B contributes $1,000 cash. 
While under their agreement each may have a ``capital account'' in the 
partnership of $1,000, the adjusted basis of A's interest is only $400 
and B's interest $1,000.
    (2) The original basis of a partner's interest in a partnership 
shall be determined under section 722 (relating to contributions to a 
partnership) or section 742 (relating to transfers of partnership 
interests). Such basis shall be increased under section 722 by any 
further contributions to the partnership

[[Page 388]]

and by the sum of the partner's distributive share for the taxable year 
and prior taxable years of:
    (i) Taxable income of the partnership as determined under section 
703(a),
    (ii) Tax-exempt receipts of the partnership, and
    (iii) The excess of the deductions for depletion over the basis of 
the depletable property, unless the property is an oil or gas property 
the basis of which has been allocated to partners under section 
613A(c)(7)(D).
    (3) The basis shall be decreased (but not below zero) by 
distributions from the partnership as provided in section 733 and by the 
sum of the partner's distributive share for the taxable year and prior 
taxable years of:
    (i) Partnership losses (including capital losses), and
    (ii) Partnership expenditures which are not deductible in computing 
partnership taxable income or loss and which are not capital 
expenditures.
    (4) The basis shall be decreased (but not below zero) by the amount 
of the partner's deduction for depletion allowable under section 611 for 
any partnership oil and gas property to the extent the deduction does 
not exceed the proportionate share of the adjusted basis of the property 
allocated to the partner under section 613A(c)(7)(D).
    (5) The basis shall be adjusted (but not below zero) to reflect any 
gain or loss to the partner resulting from a disposition by the 
partnership of a domestic oil or gas property after December 31, 1974.
    (6) For the effect of liabilities in determining the amount of 
contributions made by a partner to a partnership or the amount of 
distributions made by a partnership to a partner, see section 752 and 
Sec. 1.752-1, relating to the treatment of certain liabilities. In 
determining the basis of a partnership interest on the effective date of 
subchapter K, chapter 1 of the Code, or any of the sections thereof, the 
partner's share of partnership liabilities on that date shall be 
included.
    (b) Alternative rule. In certain cases, the adjusted basis of a 
partner's interest in a partnership may be determined by reference to 
the partner's share of the adjusted basis of partnership property which 
would be distributable upon termination of the partnership. The 
alternative rule may be used to determine the adjusted basis of a 
partner's interest where circumstances are such that the partner cannot 
practicably apply the general rule set forth in section 705(a) and 
paragraph (a) of this section, or where, from a consideration of all the 
facts, it is, in the opinion of the Commissioner, reasonable to conclude 
that the result produced will not vary substantially from the result 
obtainable under the general rule. Where the alternative rule is used, 
adjustments may be necessary in determining the adjusted basis of a 
partner's interest in a partnership. Adjustments would be required, for 
example, in order to reflect in a partner's share of the adjusted basis 
of partnership property any significant discrepancies arising as a 
result of contributed property, transfers of partnership interests, or 
distributions of property to the partners. The operation of the 
alternative rules may be illustrated by the following examples:

    Example 1. The ABC partnership, in which A, B, and C are equal 
partners, owns various properties with a total adjusted basis of $1,500 
and has earned and retained an additional $1,500. The total adjusted 
basis of partnership property is thus $3,000. Each partner's share in 
the adjusted basis of partnership property is one-third of this amount, 
or $1,000. Under the alternative rule, this amount represents each 
partner's adjusted basis for his partnership interest.
    Example 2. Assume that partner A in example 1 of this paragraph 
sells his partnership interest to D for $1,250 at a time when the 
partnership property with an adjusted basis of $1,500 had appreciated in 
value to $3,000, and when the partnership also had $750 in cash. The 
total adjusted basis of all partnership property is $2,250 and the value 
of such property is $3,750. D's basis for his partnership interest is 
his cost, $1,250. However, his one-third share of the adjusted basis of 
partnership property is only $750. Therefore, for the purposes of the 
alternative rule, D has an adjustment of $500 in determining the basis 
of his interest. This amount represents the difference between the cost 
of his partnership interest and his share of partnership basis at the 
time of his purchase. If the partnership subsequently earns and retains 
an additional $1,500, its property will have an adjusted basis of 
$3,750. D's adjusted basis for his interest under the alternative rule 
is $1,750, determined by adding $500, his basis adjustment to $1,250 
(his one-third share of

[[Page 389]]

the $3,750 adjusted basis of partnership property). If the partnership 
distributes $250 to each partner in a current distribution, D's adjusted 
basis for his interest will be $1,500 ($1,000, his one-third share of 
the remaining basis of partnership property, $3,000, plus his basis 
adjustment of $500).
    Example 3. Assume that BCD partnership in example 2 of this 
paragraph continues to operate. In 1960, D proposes to sell his 
partnership interest and wishes to evaluate the tax consequences of such 
sale. It is necessary, therefore, to determine the adjusted basis of his 
interest in the partnership. Assume further that D cannot determine the 
adjusted basis of his interest under the general rule. The balance sheet 
of the BCD partnership is as follows:

------------------------------------------------------------------------
                                                   Adjusted             
                     Assets                        basis per    Market  
                                                     books       value  
------------------------------------------------------------------------
Cash............................................      $3,000      $3,000
Receivables.....................................       4,000       4,000
Depreciable property............................       5,000       5,000
Land held for investment........................      18,000      30,000
                                                 -----------------------
    Total.......................................      30,000      42,000
------------------------------------------------------------------------


------------------------------------------------------------------------
                   Liabilities and capital                     Per books
------------------------------------------------------------------------
Liabilities.................................................      $6,000
Capital accounts:                                                       
  B.........................................................       4,500
  C.........................................................       4,500
  D.........................................................      15,000
                                                             -----------
    Total...................................................      30,000
------------------------------------------------------------------------

    The $15,000 representing the amount of D's capital account does not 
reflect the $500 basis adjustment arising from D's purchase of his 
interest. See example 2 of this paragraph. The adjusted basis of D's 
partnership interest determined under the alternative rule is as 
follows:

D's share of the adjusted basis of partnership property                 
 (reduced by the amount of liabilities) at time of proposed             
 sale.......................................................     $15,000
D's share of partnership liabilities (under the partnership             
 agreement liabilities are shared equally)..................       2,000
D's basis adjustment from example 2.........................         500
                                                             -----------
    Adjusted basis of D's interest at the time of proposed              
     sale, as determined under alternative rule.............      17,500
                                                                        


[T.D. 6500, 25 FR 11814, Nov. 26, 1960, 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8437, 57 FR 43903, Sept. 23, 1992]



Sec. 1.706-1   Taxable years of partner and partnership.

    (a) Year in which partnership income is includible. (1) In computing 
his taxable income for a taxable year, a partner is required to include 
his distributive share of partnership items set forth in section 702 for 
any partnership year ending within or with his taxable year. A partner 
shall also include in his taxable income for a taxable year ``guaranteed 
payments'' under section 707(c) which are made to him in a partnership 
taxable year ending within or with his taxable year. The provisions of 
this subparagraph may be illustrated by the following example:

    Example. Partner A reports his income for a calendar year, while the 
partnership of which he is a member reports its income for a fiscal year 
ending May 31. During the partnership taxable year ending May 31, 1956, 
A received guaranteed payments of $1,200 for services and for the use of 
capital. Of this amount, $700 was received by A between June 1 and 
December 31, 1955, and the remaining $500 was received by him between 
January 1 and May 31, 1956. This entire $1,200 received by A is 
includible in his taxable income for the calendar year 1956 (together 
with his distributive share of partnership items set forth in section 
702 for the partnership taxable year ending May 31, 1956).

    (2) If a partner receives distributions under section 731 or sells 
or exchanges all or part of his partnership interest, any gain or loss 
arising therefrom does not constitute partnership income and is 
includible in the partner's gross income for his taxable year in which 
the payment is made. See sections 451 and 461.
    (b) Adoption or change in taxable year--(1) Partnership taxable 
year. (i) The taxable year of a partnership shall be determined as 
though the partnership were a taxpayer.
    (ii) A newly formed partnership may adopt a taxable year which is 
the same as the taxable year of all its principal partners (or the same 
as the taxable year to which all of its principal partners are 
concurrently changing) without securing prior approval from the 
Commissioner, or it may adopt a calendar year without securing prior 
approval from the Commissioner if all its principal partners are not on 
the same taxable year. In any other case, a newly formed partnership 
must secure prior approval from the Commissioner for the adoption of a 
taxable year.
    (iii) An existing partnership may not change its taxable year 
without securing prior approval from the Commissioner, unless all its 
principal partners

[[Page 390]]

have the same taxable year to which the partnership changes, or unless 
all its principal partners concurrently change to such taxable year.
    (2) Partner's taxable year. A partner may not change his taxable 
year without securing prior approval from the Commissioner. See section 
442 and the regulations thereunder.
    (3) Principal partner. For the purpose of this paragraph, a 
principal partner is a partner having an interest of 5 percent or more 
in partnership profits or capital.
    (4) Application for approval--(i) Change. Application for a change 
in a taxable year shall be filed on Form 1128 with the Commissioner of 
Internal Revenue, Washington, DC 20224. If the short period involved in 
the change ends after December 31, 1973, such form shall be filed on or 
before the 15th day of the second calendar month following the close of 
such short period; if such short period ends before January 1, 1974, 
such form shall be filed on or before the last day of the first calendar 
month following the close of such short period.
    (ii) Adoption. Where a newly formed partnership is required to 
secure prior approval from the Commissioner for the adoption of a 
taxable year, the partnership shall file an application on Form 1128 
with the Commissioner on or before the last day of the month following 
the close of the taxable year to be adopted. The partnership shall 
modify Form 1128 to the extent necessary to indicate that it is an 
application for adoption of a taxable year.
    (iii) Business purpose. Where prior approval is required under this 
paragraph, the applicant must establish a business purpose to the 
satisfaction of the Commissioner. For example, partnership AB, which is 
on a calendar year, is engaged in a business which has a natural 
business year (the annual accounting period encompassing all related 
income and expenses) ending on September 30th. The intention of the 
partnership to make its tax year coincide with such natural business 
year constitutes a sufficient business purpose.
    (5) Returns--(i) Partner. A partner who changes his taxable year 
shall make his return for a short period in accordance with section 443, 
and shall attach to the return a copy of the letter from the 
Commissioner granting approval for the change of taxable year.
    (ii) Partnership. (a) A partnership which changes its taxable year 
shall make its return for a short period in accordance with section 443, 
but shall not annualize the partnership taxable income. The partnership 
shall attach to the return either a copy of the letter from the 
Commissioner granting approval of the change of taxable year, or a 
statement indicating that the partnership is changing its taxable year 
to the same taxable year as that of all its principal partners or to the 
same taxable year as that to which all its principal partners are 
concurrently changing.
    (b) Any newly formed partnership shall file with its first return 
either:
    (1) A copy of the letter from the Commissioner approving the 
adoption of a partnership taxable year which is not the same as the 
taxable year of all its principal partners; or
    (2) A statement indicating that the taxable year it has adopted is 
the same as the taxable year of all its principal partners, or that all 
its principal partners are concurrently changing to the taxable year it 
has adopted; or
    (3) A statement that all its principal partners are not on the same 
taxable year and that it is adopting a calendar year without prior 
approval.
    (6) Effective date. Section 706(b) applies to any partnership which 
adopts or changes to a taxable year beginning on or after April 2, 1954, 
and to any partner who changes to a taxable year beginning on or after 
that date. For the purpose of applying this provision, section 708 
(relating to the continuation of a partnership) applies to any such 
taxable year. See section 771(b)(1) and paragraph (b)(1) of Sec. 1.771-
1. If a partnership has changed to or adopted, or if a partner has 
changed to, a taxable year beginning on or after April 2, 1954, without 
obtaining prior approval of the Commissioner, and if, under the 
provisions of this paragraph, prior approval is required for the change 
or adoption, such annual accounting period will not be accepted as a 
taxable year until approval thereof is secured.

[[Page 391]]

Under these circumstances, an application to change to or adopt the 
desired taxable year will be considered timely if filed before August 
23, 1956.
    (7) Cross-reference to Sec. 1.442-2T and Sec. 1.442-3T. For special 
rules applicable to certain changes in annual accounting period where 
the short period involved in the change ends in 1986 or 1987, see 
Sec. 1.442-2T. For special rules applicable to certain adoptions and 
retentions of a taxable year ending in 1986 or 1987, see Sec. 1.442-3T.
    (c) Closing of partnership year--(1) General rule. Section 706(c) 
and this paragraph provide rules governing the closing of partnership 
years. The closing of a partnership taxable year or a termination of a 
partnership for Federal income tax purposes is not necessarily governed 
by the ``dissolution'', ``liquidation'', etc., of a partnership under 
State or local law. The taxable year of a partnership shall not close as 
the result of the death of a partner, the entry of a new partner, the 
liquidation of a partner's entire interest in the partnership (as 
defined in section 761(d)), or the sale or exchange of a partner's 
interest in the partnership, except in the case of a termination of a 
partnership and except as provided in subparagraph (2) of this 
paragraph. In the case of termination, the partnership taxable year 
closes for all partners as of the date of termination. See section 
708(b) and paragraph (b) of Sec. 1.708-1.
    (2) Partner who retires or sells interest in partnership--(i) 
Disposition of entire interest. A partnership taxable year shall close 
with respect to a partner who sells or exchanges his entire interest in 
a partnership, and with respect to a partner whose entire interest is 
liquidated. However, a partnership taxable year with respect to a 
partner who dies shall not close prior to the end of such partnership 
taxable year, or the time when such partner's interest (held by his 
estate or other successor) is liquidated or sold or exchanged, whichever 
is earlier. See subparagraph (3) of this paragraph.
    (ii) Inclusions in taxable income. In the case of a sale, exchange, 
or liquidation of a partner's entire interest in a partnership, the 
partner shall include in his taxable income for his taxable year within 
or with which his membership in the partnership ends, his distributive 
share of items described in section 702(a), and any guaranteed payments 
under section 707(c), for his partnership taxable year ending with the 
date of such sale, exchange, or liquidation. In order to avoid an 
interim closing of the partnership books, such partner's distributive 
share of items described in section 702(a) may, by agreement among the 
partners, be estimated by taking his pro rata part of the amount of such 
items he would have included in his taxable income had he remained a 
partner until the end of the partnership taxable year. The proration may 
be based on the portion of the taxable year that has elapsed prior to 
the sale, exchange, or liquidation, or may be determined under any other 
method that is reasonable. Any partner who is the transferee of such 
partner's interest shall include in his taxable income, as his 
distributive share of items described in section 702(a) with respect to 
the acquired interest, the pro rata part (determined by the method used 
by the transferor partner) of the amount of such items he would have 
included had he been a partner from the beginning of the taxable year of 
the partnership. The application of this subdivision may be illustrated 
by the following example:

    Example. Assume that a partner selling his partnership interest on 
June 30, 1955, has an adjusted basis for his interest of $5,000 on that 
date; that his pro rata share of partnership income up to June 30 is 
$15,000; and that he sells his interest for $20,000. Under the 
provisions of section 706(c)(2), the partnership year with respect to 
him closes at the time of the sale. The $15,000 is includible in his 
income as his distributive share and, under section 705, it increases 
the basis of his partnership interest to $20,000, which is also the 
selling price of his interest. Therefore, no gain is realized on the 
sale of his partnership interest. The purchaser of this partnership 
interest shall include in his income as his distributive share his pro 
rata part of partnership income for the remainder of the partnership 
taxable year.

    (3) Partner who dies. (i) When a partner dies, the partnership 
taxable year shall not close with respect to such partner prior to the 
end of the partnership taxable year. The partnership taxable year shall 
continue both for the

[[Page 392]]

remaining partners and the decedent partner. Where the death of a 
partner results in the termination of the partnership, the partnership 
taxable year shall close for all partners on the date of such 
termination under section 708(b)(1)(A). See also paragraph (b)(1)(i)(b) 
of Sec. 1.708-1 for the continuation of a 2-member partnership under 
certain circumstances after the death of a partner. However, if the 
decedent partner's estate or other successor sells or exchanges its 
entire interest in the partnership, or if its entire interest is 
liquidated, the partnership taxable year with respect to the estate or 
other successor in interest shall close on the date of such sale or 
exchange, or the date of completion of the liquidation.
    (ii) The last return of a decedent partner shall include only his 
share of partnership taxable income for any partnership taxable year or 
years ending within or with the last taxable year for such decedent 
partner (i. e., the year ending with the date of his death). The 
distributive share of partnership taxable income for a partnership 
taxable year ending after the decedent's last taxable year is includible 
in the return of his estate or other successor in interest. If the 
estate or other successor in interest of a partner continues to share in 
the profits or losses of the partnership business, the distributives 
share thereof is includible in the taxable year of the estate or other 
successor in interest within or with which the taxable year of the 
partnership ends. See also paragraph (a)(1)(ii) of Sec. 1.736-1. Where 
the estate or other successor in interest receives distributions, any 
gain or loss on such distributions is includible in its gross income for 
its taxable year in which the distribution is made.
    (iii) If a partner (or a retiring partner), in accordance with the 
terms of the partnership agreement, designates a person to succeed to 
his interest in the partnership after his death, such designated person 
shall be regarded as a successor in interest of the deceased for 
purposes of this chapter. Thus, where a partner designates his widow as 
the successor in interest, her distributive share of income for the 
taxable year of the partnership ending within or with her taxable year 
may be included in a joint return in accordance with the provisions of 
sections 2 and 6013(a) (2) and (3).
    (iv) If, under the terms of an agreement existing at the date of 
death of a partner, a sale or exchange of the decedent partner's 
interest in the partnership occurs upon that date, then the taxable year 
of the partnership with respect to such decedent partner shall close 
upon the date of death. See section 706(c)(2)(A)(i). The sale or 
exchange of a partnership interest does not, for the purpose of this 
rule, include any transfer of a partnership interest which occurs at 
death as a result of inheritance or any testamentary disposition.
    (v) To the extent that any part of a distributive share of 
partnership income of the estate or other successor in interest of a 
deceased partner is attributable to the decedent for the period ending 
with the date of his death, such part of the distributive share is 
income in respect of the decedent under section 691. See section 691 and 
the regulations thereunder.
    (vi) The provisions of this subparagraph may be illustrated by the 
following examples:

    Example 1. B has a taxable year ending December 31 and is a member 
of partnership ABC, the taxable year of which ends on June 30. B dies on 
October 31, 1955. His estate (which as a new taxpayer may, under section 
441 and the regulations thereunder, adopt any taxable year) adopts a 
taxable year ending October 31. The return of the decedent for the 
period January 1 to October 31, 1955, will include only his distributive 
share of taxable income of the partnership for its taxable year ending 
June 30, 1955. The distributive share of taxable income of the 
partnership for its taxable year ending June 30, 1956, arising from the 
interest of the decedent, will be includible in the return of the estate 
for its taxable year ending October 31, 1956. That part of the 
distributive share attributable to the decedent for the period ending 
with the date of his death (July 1 through October 31, 1955) is income 
in respect of a decedent under section 691.
    Example 2. Assume the same facts as in example 1 of this 
subdivision, except that, prior to B's death, B and D had agreed that, 
upon B's death, D would purchase B's interest for $10,000. When B dies 
on October 31, 1955, the partnership taxable year beginning July 1, 
1955, closes with respect to him. Therefore, the return for B's last 
taxable

[[Page 393]]

year (January 1 to October 31, 1955) will include his distributive share 
of taxable income of the partnership for its taxable year ending June 
30, 1955, plus his distributive share of partnership taxable income for 
the period July 1 to October 31, 1955. See subdivision (iv) of this 
subparagraph.
    Example 3. H is a member of a partnership having a taxable year 
ending December 31. Both H and his wife W are on a calendar year and 
file joint returns. H dies on March 31, 1955. Administration of the 
estate is completed and the estate, including the partnership interest, 
is distributed to W as legatee on November 30, 1955. Such distribution 
by the estate is not a sale or exchange of H's partnership interest. No 
part of the taxable income of the partnership for the taxable year 
ending December 31, 1955, which is allocable to H, will be included in 
H's taxable income for his last taxable year (January 1 through March 
31, 1955) or in the taxable income of H's estate for the taxable year 
April 1 through November 30, 1955. The distributive share of partnership 
taxable income for the full calendar year that is allocable to H will be 
includible in the taxable income of W for her taxable year ending 
December 31, 1955, and she may file a joint return under sections 2 and 
6013(a)(3). That part of the distributive share attributable to the 
decedent for the period ending with the date of his death (January 1 
through March 31, 1955) is income in respect of a decedent under section 
691.
    Example 4. M is a member of partnership JKM which operates on a 
calendar year. M and his wife S file joint returns for calendar years. 
In accordance with the partnership agreement, M designated S to succeed 
to his interest in the partnership upon his death. M, who had withdrawn 
$10,000 from the partnership before his death, dies on October 20, 1955. 
S's distributive share of income for the taxable year 1955 is $15,000 
($10,000 of which represents the amount withdrawn by M). S shall include 
$15,000 in her income, even though M received $10,000 of this amount 
before his death. S may file a joint return with M for the year 1955 
under sections 2 and 6013(a). That part of the $15,000 distributive 
share attributable to the decedent for the period ending with the date 
of his death (January 1 through October 20, 1955) is income in respect 
of a decedent under section 691.

    (4) Disposition of less than entire interest. If a partner sells or 
exchanges a part of his interest in a partnership, or if the interest of 
a partner is reduced, the partnership taxable year shall continue to its 
normal end. In such case, the partner's distributive share of items 
which he is required to include in his taxable income under the 
provisions of section 702(a) shall be determined by taking into account 
his varying interests in the partnership during the partnership taxable 
year in which such sale, exchange, or reduction of interest occurred.
    (5) Transfer of interest by gift. The transfer of a partnership 
interest by gift does not close the partnership taxable year with 
respect to the donor. However, the income up to the date of gift 
attributable to the donor's interest shall be allocated to him under 
section 704(e)(2).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7286, 38 FR 26912, Sept. 27, 1973; T.D. 8123, 52 FR 
3623, Feb. 5, 1987]



Sec. 1.706-1T  Taxable years of certain partnerships (temporary).

    (a) Taxable year determined by reference to the partners--(1) In 
general. If for any taxable year a partnership's taxable year cannot be 
determined by reference to the taxable year of its partners owning a 
majority interest in partnership profits and capital (as described in 
section 706(b)(1)(B)(i)) or by reference to the taxable year of all its 
principal partners (as described in section 706(b)(1)(B)(ii)), then the 
partnership must determine its taxable year under section 
706(b)(1)(B)(iii). Under section 706(b)(1)(B)(iii), the taxable year of 
the partnership, except as provided in paragraph (b) of this section, 
shall be the taxable year that results in the least aggregate deferral 
of income to the partners (as determined under paragraph (a)(2) of this 
section). See Sec. 1.706-3T(a) for special rules which provide that 
certain tax-exempt partners are disregarded.
    (2) Taxable year that results in the least aggregate deferral of 
income. The taxable year that results in the least aggregate deferral of 
income will be the taxable year of one or more of the partners in the 
partnership which will result in the least aggregate deferral of income 
to the partners. The aggregate deferral for a particular year is equal 
to the sum of the products determined by multiplying the month(s) of 
deferral for each partner that would be generated by that year and each 
partner's interest in partnership profits for that year. The partner's 
taxable year that

[[Page 394]]

produces the lowest sum when compared to the other partner's taxable 
years is the taxable year that results in the least aggregate deferral 
of income to the partners. If the calculation results in more than one 
taxable year qualifying as the taxable year with the least aggregate 
deferral, the partnership may select any one of those taxable years as 
its taxable year. However, if one of the qualifying taxable years is 
also the partnership's existing taxable year, the partnership must 
maintain its existing taxable year. The determination of the taxable 
year that results in the least aggregate deferral of income shall 
generally be made as of the beginning of the partnership's current 
taxable year. The district director, however, may determine that the 
first day of the current taxable year is not the appropriate testing day 
and require the use of some other day or period that will more 
accurately reflect the ownership of the partnership and thereby the 
actual aggregate deferral to the partners where the partners engage in a 
transaction that has as its principal purpose the avoidance of the 
principles of this section. Thus, for example the preceding sentence 
would apply where there is a transfer of an interest in the partnership 
that results in a temporary transfer of that interest principally for 
purposes of qualifying for a specific taxable year under the principles 
of this section. For purposes of this section, deferral to each partner 
is measured in terms of months from the end of the partnership's taxable 
year forward to the end of the partner's taxable year.
    (3) Determination of the taxable year of a partner or partnership 
that uses a 52-53 week taxable year. For purposes of the calculation 
described in paragraph (a)(2) of this section, the taxable year of a 
partner or partnership that uses a 52-53 week taxable year shall be the 
same year determined under the rules of section 441(f) and the 
regulations thereunder with respect to the inclusion of income by the 
partner or partnership.
    (4) Special de minimis rule. If the taxable year that results in the 
least aggregate deferral produces an aggregate deferral that is less 
than .5 when compared to the aggregate deferral of the current taxable 
year, the partnership's current taxable year shall be treated as the 
taxable year with the least aggregate deferral. Thus, the partnership 
will not be permitted to change its taxable year. However, this de 
minimis rule will not apply to the first taxable period beginning after 
December 31, 1986.
    (b) Business purpose. A partnership may have a taxable year other 
than the year described in paragraph (a) of this section if it 
establishes, to the satisfaction of the Commissioner of Internal 
Revenue, a business purpose for such taxable year in accordance with and 
under the procedures established in Sec. 1.442-1(b)(1). For purposes of 
this paragraph (b), any deferral of income to partners shall not be 
treated as a business purpose.
    (c) Procedural requirements and effective date--(1) In general. The 
change in accounting period required by paragraph (a) of this section 
shall be treated as initiated by the partnership and made with the 
consent of the Commissioner. To effect the change, a partnership must 
show that the requirements of this section are satisfied in a statement 
setting forth the computations required to establish the taxable year 
that results in the least aggregate deferral of income to the partners 
under paragraph (a) of this section. The partnership must attach the 
statement to the income tax return for the short period involved in the 
changes and must indicate the following at the top of page 1 of the 
return: ``FILED UNDER Sec. 1.706-1T.''
    (2) Effective date--(i) In general. Except as provided in paragraph 
(c)(2)(ii) of this section, the rules of this section are effective for 
partnership taxable years beginning after December 31, 1986.
    (ii) Special rule for first taxable year beginning after December 
31, 1986. A partnership otherwise required to change its accounting 
period for its first taxable year beginning after December 31, 1986 to a 
year resulting in the least aggregate deferral of income to its partners 
under paragraph (a) of this section, may, at its option, delay the 
application of the rules of that paragraph until its first taxable year 
beginning after December 31, 1987. In such a case,

[[Page 395]]

the partnership must conform its first taxable year beginning after 
December 31, 1986 to the calendar year and must apply the rules of 
paragraph (a) of this section to its first taxable year beginning after 
December 31, 1987. See Sec. 1.702-3T(a)(1) regarding the availability of 
a 4-year spread provision with respect to a partnership required to 
change its taxable year for its first taxable year beginning after 
December 31, 1986.
    (iii) Special eligibility for 4-year spread; years beginning after 
December 31, 1987. Notwithstanding the provisions of Sec. 1.702-3T(a)(1) 
limiting the availability of the 4-year spread provisions to a 
partnership's first taxable year beginning after December 31, 1986, if--
    (A) A partnership is required under section 706(b)(1)(B)(iii) and 
paragraph (a) of this section to change to a taxable year that results 
in the least aggregate deferral of income to the partners for a 
partnership's first taxable year beginning after December 31, 1987,
    (B) The partnership did exercise its option, as provided in 
paragraph (c)(2)(ii) of this section, to delay the application of the 
rules of paragraph (a) of this section until the partnership's first 
taxable year beginning after December 31, 1987, and
    (C) The partnership would have been required to change its 
accounting period under section 706(b)(1)(B)(iii) and paragraph (a) of 
this section for its first taxable year beginning after December 31, 
1986, if paragraph (a) of this section had been applicable to such 
taxable year, the partners in the partnership will be eligible to 
utilize the 4-year spread provision provided in Sec. 1.702-3T (subject 
to the other requirements of that section) with respect to the 
partnership's change in accounting period required under section 
706(b)(1)(B)(iii) and paragraph (a) of this section for the 
partnership's first taxable year beginning after December 31, 1987.
    (d) Examples. The principles of this section may be illustrated by 
the following examples:

    Example 1. Partnership P is on a fiscal year ending June 30. Partner 
A reports income on the fiscal year ending June 30 and Partner B reports 
income on the fiscal year ending July 31. A and B each have a 50 percent 
interest in partnership profits. For its taxable year beginning July 1, 
1987, the partnership will be required to retain its taxable year since 
the fiscal year ending June 30 results in the least aggregate deferral 
of income to the partners. This determination is made as follows:

------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 6/30              End   Partnership   for 6/30      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................    6/30          .5           0          0
Partner B....................    7/31          .5           1         .5
                                                              ----------
    Aggregate deferral.......................................         .5
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 7/31              End   Partnership   for 7/31      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................    6/30          .5          11        5.5
Partner B....................    7/31          .5           0          0
                                                              ----------
    Aggregate deferral.......................................        5.5
------------------------------------------------------------------------

    Example 2. The facts are the same as in Example 1 except that A 
reports income on the calendar year and B reports on the fiscal year 
ending November 30. For the partnership's taxable year beginning July 1, 
1987, the partnership is required to change its taxable year to a fiscal 
year ending November 30 because such year results in the least aggregate 
deferral of income to the partners. This determination is made as 
follows:


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 12/31             End   Partnership  for 12/31      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................   12/31          .5           0          0
Partner B....................   11/30          .5          11        5.5
                                                              ----------
    Aggregate deferral.......................................        5.5
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 11/30             End   Partnership  for 11/30      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................   12/31          .5           1         .5
Partner B....................   11/30          .5           0          0
                                                              ----------
    Aggregate deferral.......................................         .5
------------------------------------------------------------------------

    Example 3. The facts are the same as in Example 2 except that B 
reports income on the fiscal year ending June 30. For the partnership's 
taxable year beginning July 1, 1987, each partner's taxable year will 
result in identical aggregate deferral of income. If the partnership's 
current taxable year was neither a fiscal year ending June 30 nor the 
calendar year, the partnership would select either the fiscal year 
ending June 30 or the calendar year as its taxable year. However, since 
the partnership's current taxable year

[[Page 396]]

ends June 30, it must retain its current taxable year.

------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 12/31             End   Partnership  for 12/31      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................   12/31          .5           0          0
Partner B....................    6/30          .5           6        3.0
                                                              ----------
    Aggregate deferral.......................................        3.0
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 6/30              End   Partnership   for 6/30      x    
                                         Profits     Year End   Deferral
------------------------------------------------------------------------
Partner A....................   12/31          .5           6        3.0
Partner B....................    6/30          .5           0          0
                                                              ----------
    Aggregate deferral.......................................        3.0
------------------------------------------------------------------------

    Example 4. The facts are the same as in Example 1 except that on 
December 31, 1987, partner A sells a 4 percent interest in the 
partnership to Partner C, who reports income on the fiscal year ending 
June 30, and a 40 percent interest in the partnership to Partner D, who 
also reports income on the fiscal year ending June 30. The taxable year 
beginning July 1, 1987, is unaffected by the sale. However, for the 
taxable year beginning July 31, 1988, the partnership must determine the 
taxable year resulting in the least aggregate deferral as of July 1, 
1988. In this case, the partnership will be required to retain its 
taxable year since the fiscal year ending June 30 continues to be the 
taxable year that results in the least aggregate deferral of income to 
the partners.
    Example 5. The facts are the same as in Example 4 except that 
Partner D reports income on the fiscal year ending April 30. As in 
Example 4, the taxable year during which the sale took place is 
unaffected by the shifts in interests. However, for its taxable year 
beginning July 1, 1988, the partnership will be required to change its 
taxable year to the fiscal year ending April 30. This determination is 
made as follows:

------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 7/31              End   Partnership   for 7/31      x    
                                         Profits     Year End  Deferral.
------------------------------------------------------------------------
Partner A....................    6/30         .06          11        .66
Partner B....................    7/31          .5           0          0
Partner C....................    6/30         .04          11        .44
Partner D....................    4/30          .4           9       3.60
                                                              ----------
    Aggregate deferral.......................................       4.70
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 6/30              End   Partnership   for 6/30      x    
                                         Profits     Year End  Deferral.
------------------------------------------------------------------------
Partner A....................    6/30         .06           0          0
Partner B....................    7/31          .5           1         .5
Partner C....................    6/30         .04           0          0
Partner D....................    4/30          .4          10        4.0
                                                              ----------
    Aggregate deferral.......................................        4.5
------------------------------------------------------------------------


------------------------------------------------------------------------
                                                    Months of           
                                Year   Interest in   Deferral   Interest
          Test 4/30              End   Partnership   for 4/30      x    
                                         Profits     Year End  Deferral.
------------------------------------------------------------------------
Partner A....................    6/30         .06           2        .12
Partner B....................    7/31          .5           3       1.50
Partner C....................    6/30         .04           2        .08
Partner D....................    4/30          .4           0          0
                                                              ----------
      Aggregate deferral.....................................       1.70
------------------------------------------------------------------------


Sec.  1.706-1T(a)(4) Test:                                              
                                                                        
  Current taxable year (June 30)...............................      4.5
  Less: Taxable year producing the least aggregate deferral             
   (April 30)..................................................      1.7
                                                                --------
    Additional aggregate deferral (greater than .5)............      2.8
------------------------------------------------------------------------

    Example 6. Partnership P has two partners, A who reports income on 
the fiscal year ending March 31, and B who reports income on the fiscal 
year ending July 31. A and B share profits equally. P has determined its 
taxable year under Sec. 1.706-1T(a)(2) to be the fiscal year ending 
March 31 as follows:

----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                             Test 3/31                                Year    Partnership    for 3/31      x    
                                                                       End      Profits      Year End  Deferral.
----------------------------------------------------------------------------------------------------------------
Partner A..........................................................    3/31         .5              0          0
Partner B..........................................................    7/31         .5              4          2
                                                                                                      ----------
      Aggregate deferral.............................................................................          2
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                             Test 7/31                                Year    Partnership    for 7/31      x    
                                                                       End      Profits      Year End  Deferral.
----------------------------------------------------------------------------------------------------------------
Partner A..........................................................    3/31         .5              8          4
Partner B..........................................................    7/31         .5              0          0
                                                                                                      ----------
      Aggregate deferral.............................................................................          4
----------------------------------------------------------------------------------------------------------------

    In May 1988, Partner A sells a 45 percent interest in the 
partnership to C, who reports income on the fiscal year ending April 30. 
For the taxable period beginning April 1, 1989, the fiscal year ending 
April 30 is the taxable year that produces the least aggregate deferral 
of income to the partners. However, under paragraph (a)(4) of this 
section the partnership is required to retain its fiscal year ending 
March 31. This determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                             Test 3/31                                Year    Partnership    for 3/31      x    
                                                                       End      Profits      Year End  Deferral.
----------------------------------------------------------------------------------------------------------------
Partner A..........................................................    3/31         .05             0         0 
Partner B..........................................................    7/31         .5              4       2.0 

[[Page 397]]

                                                                                                                
Partner C..........................................................    4/30         .45             1        .45
                                                                                                      ----------
      Aggregate deferral.............................................................................       2.45
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
                                       Interest in    Deferral          
          Test 7/31            Year    Partnership    for 7/31  Interest
                                End      Profits      year end  Deferral
------------------------------------------------------------------------
Partner A...................    3/31         .05             8       .40
Partner B...................    7/31         .5              0         0
Partner C...................    4/30         .45             9      4.05
                                                               ---------
    Aggregate deferral........................................      4.45
------------------------------------------------------------------------


------------------------------------------------------------------------
                                       Interest in    Deferral          
          Test 4/30            Year    Partnership    for 4/30  Interest
                                End      Profits      year end  Deferral
------------------------------------------------------------------------
Partner A...................    3/31         .05            11       .55
Partner B...................    7/31         .5              3      1.50
Partner C...................    4/30         .45             0         0
                                                               ---------
    Aggregate deferral........................................      2.05
------------------------------------------------------------------------


Sec.  1.706-1T(a)(4) Test:                                              
                                                                        
  Current taxable year (3/31)..................................     2.45
  Less: Taxable year producing the least aggregate deferral (4/         
   30).........................................................     2.05
                                                                --------
    Additional aggregate deferral (less than .5)...............      .40
------------------------------------------------------------------------

[T.D. 8169, 52 FR 48995, Dec. 29, 1987; 53 FR 1441, Jan. 19, 1988, as 
amended by T.D. 8205, 53 FR 19711, May 27, 1988]



Sec. 1.706-2T  Temporary regulations; question and answer under the Tax Reform Act of 1984.

    Question 1: For purposes of section 706(d), how is an otherwise 
deductible amount that is deferred under section 267(a)(2) treated?
    Answer 1: In the year the deduction is allowed, the deduction will 
constitute an allocable cash basis item under section 706(d)(2)(B)(iv).

(Secs. 267(f)(2)(B), 706(d)(2)(B)(iv), 1502, and 7805, Internal Revenue 
Code of 1954 (98 Stat. 704, 26 U.S.C. 267; 98 Stat. 589, 26 U.S.C. 706; 
68A Stat. 367, 26 U.S.C. 1502; 68A Stat. 917, 26 U.S.C. 7805))

[T.D. 7991, 49 FR 47001, Nov. 30, 1984]



Sec. 1.706-3T  Temporary regulations under the Tax Reform Act of 1986 and the Revenue Act of 1987 (temporary).

    (a) Certain tax-exempt partners disregarded--(1) General rule. In 
determining the taxable year (the ``current year'') of a partnership 
under section 706(b) and the regulations thereunder, a partner that is 
tax-exempt under section 501(a) shall be disregarded if such partner was 
not subject to tax, under chapter 1 of the Code, on any income 
attributable to its investment in the partnership during the 
partnership's taxable year immediately preceding the current year. 
However, if a partner that is tax-exempt under section 501(a) was not a 
partner during the partnership's immediately preceding taxable year, 
such partner will be disregarded for the current year if the partnership 
reasonably believes that the partner will not be subject to tax, under 
chapter 1 of the Code, on any income attributable to such partner's 
investment in the partnership during the current year.
    (2) Example. The provisions of paragraph (a)(1) of this section may 
be illustrated by the following example.

    Example. Assume that partnership A has historically used the 
calendar year as its taxable year. In addition, assume that A is owned 
by 5 partners, 4 calendar year individuals (each owning 10 percent of 
A's profits and capital) and a tax-exempt organization (owning 60 
percent of A's profits and capital). The tax-exempt organization has 
never had unrelated business taxable income with respect to A and has 
historically used a June 30 fiscal year. Finally, assume that A desires 
to retain the calendar year for its taxable year beginning January 1, 
1987. Under these facts and but for the special rule in paragraph (a)(1) 
of this section, A would be required under section 706(b)(1)(B)(i) to 
change to a year ending June 30, for its taxable year beginning January 
1, 1987. However, under the special rule provided in paragraph (a)(1) of 
this section, and assuming the optional effective date provided in 
paragraph (c) of this section is chosen, the partner that is tax-exempt 
is disregarded, and A must retain the calendar year, under section 
706(b)(1)(B)(i), for its taxable year beginning January 1, 1987.

    (b) Effect of partner elections under section 444. For purposes of 
section 706(b)(1)(B), any section 444 election by a partner in a 
partnership shall be taken into account in determining the taxable year 
of the partnership. See example 4 of Sec. 1.7519-1T(d).
    (c) Effective date. The provisions of this section are generally 
effective for taxable years beginning after December 31, 1987. However, 
a partnership may, at its option, apply the provisions

[[Page 398]]

of this section for taxable years beginning after December 31, 1986.

[T.D. 8205, 53 FR 19710, May 27, 1988]



Sec. 1.707-0  Table of contents.

    This section lists the captions that appear in Secs. 1.707-1 through 
1.707-9.

      Section 1.707-1  Transactions Between Partner and Partnership

(a) Partner not acting in capacity as partner.
(b) Certain sales or exchanges of property with respect to controlled 
          partnerships.
(1) Losses disallowed.
(2) Gains treated as ordinary income.
(3) Ownership of a capital or profits interest.
(c) Guaranteed payments.

      Section 1.707-2  Disguised Payments for Services. [Reserved]

  Section 1.707-3  Disguised Sales of Property to Partnership; General 
                                  Rule.

(a) Treatment of transfers as a sale.
(1) In general.
(2) Definition and timing of sale.
(3) Application of disguised sale rules.
(4) Deemed terminations under section 708.
(b) Transfers treated as a sale.
(1) In general.
(2) Facts and circumstances.
(c) Transfers made within two years presumed to be a sale.
(1) In general.
(2) Disclosure of transfers made within two years.
(d) Transfers made more than two years apart presumed not to be a sale.
(e) Scope.
(f) Examples.

  Section 1.707-4  Disguised Sales of Property to Partnership; Special 
 Rules Applicable to Guaranteed Payments, Preferred Returns, Operating 
Cash Flow Distributions, and Reimbursements of Preformation Expenditures

(a) Guaranteed payments and preferred returns.
(1) Guaranteed payment not treated as part of a sale.
(i) In general.
(ii) Reasonable guaranteed payments.
(iii) Unreasonable guaranteed payments.
(2) Presumption regarding reasonable preferred returns.
(3) Definition of reasonable preferred returns and guaranteed payments.
(i) In general.
(ii) Reasonable amount.
(4) Examples.
(b) Presumption regarding operating cash flow distributions.
(1) In general.
(2) Operating cash flow distributions.
(i) In general.
(ii) Operating cash flow safe harbor.
(iii) Tiered partnerships.
(c) Accumulation of guaranteed payments, preferred returns, and 
          operating cash flow distributions.
(d) Exception for reimbursements of preformation expenditures.
(e) Other exceptions.

  Section 1.707-5  Disguised Sales of Property to Partnership; Special 
                      Rules Relating to Liabilities

(a) Liability assumed or taken subject to by partnership.
(1) In general.
(2) Partner's share of liability.
(i) Recourse liability.
(ii) Nonrecourse liability.
(3) Reduction of partner's share of liability.
(4) Special rule applicable to transfers of encumbered property to a 
          partnership by more than one partner pursuant to a plan.
(5) Special rule applicable to qualified liabilities.
(6) Qualified liability of a partner defined.
(7) Liability incurred within two years of transfer presumed to be in 
          anticipation of the transfer.
(i) In general.
(ii) Disclosure of transfers of property subject to liabilities incurred 
          within two years of the transfer.
(b) Treatment of debt-financed transfers of consideration by 
          partnerships.
(1) In general.
(2) Partner's allocable share of liability.
(i) In general.
(ii) Debt-financed transfers made pursuant to a plan.
(A) In general.
(B) Special rule.
(iii) Reduction of partner's share of liability.
(c) Refinancings.
(d) Share of liability where assumption accompanied by transfer of 
          money.
(e) Tiered partnerships and other related persons.
(f) Examples.

Section 1.707-6  Disguised Sales of Property by Partnership to Partner; 
                              General Rules

(a) In general.
(b) Special rules relating to liabilities.
(1) In general.
(2) Qualified liabilities.
(c) Disclosure rules.
(d) Examples.

  Section 1.707-7  Disguised Sales of Partnership Interests. [Reserved]

           Section 1.707-8  Disclosure of Certain Information

(a) In general.

[[Page 399]]

(b) Method of providing disclosure.
(c) Disclosure by certain partnerships.

         Section 1.707-9  Effective Dates and Transitional Rules

(a) Sections 1.707-3 through 1.707-6.
(1) In general.
(2) Transfers occurring on or before April 24, 1991.
(3) Effective date of section 73 of the Tax Reform Act of 1984.
(b) Section 1.707-8 disclosure of certain information.

[T.D. 8439, 57 FR 44978, Sept. 30, 1992]



Sec. 1.707-1   Transactions between partner and partnership.

    (a) Partner not acting in capacity as partner. A partner who engages 
in a transaction with a partnership other than in his capacity as a 
partner shall be treated as if he were not a member of the partnership 
with respect to such transaction. Such transactions include, for 
example, loans of money or property by the partnership to the partner or 
by the partner to the partnership, the sale of property by the partner 
to the partnership, the purchase of property by the partner from the 
partnership, and the rendering of services by the partnership to the 
partner or by the partner to the partnership. Where a partner retains 
the ownership of property but allows the partnership to use such 
separately owned property for partnership purposes (for example, to 
obtain credit or to secure firm creditors by guaranty, pledge, or other 
agreement) the transaction is treated as one between a partnership and a 
partner not acting in his capacity as a partner. However, transfers of 
money or property by a partner to a partnership as contributions, or 
transfers of money or property by a partnership to a partner as 
distributions, are not transactions included within the provisions of 
this section. In all cases, the substance of the transaction will govern 
rather than its form. See paragraph(c)(3) of Sec. 1.731-1.
    (b) Certain sales or exchanges of property with respect to 
controlled partnerships--(1) Losses disallowed. (i) No deduction shall 
be allowed for a loss on a sale or exchange of property (other than an 
interest in the partnership, directly or indirectly, between a 
partnership and a partner who owns, directly or indirectly, more than 50 
percent of the capital interest or profits interest in such partnership. 
A loss on a sale or exchange of property, directly or indirectly, 
between two partnerships in which the same persons own, directly or 
indirectly, more than 50 percent of the capital interest or profits 
interest in each partnership shall not be allowed.
    (ii) If a gain is realized upon the subsequent sale or exchange by a 
transferee of property with respect to which a loss was disallowed under 
the provisions of subdivision (i) of this subparagraph, section 267(d) 
(relating to amount of gain where loss previously disallowed) shall 
apply as though the loss were disallowed under section 267(a)(1).
    (2) Gains treated as ordinary income. Any gain recognized upon the 
sale or exchange, directly or indirectly, of property which, in the 
hands of the transferee immediately after the transfer, is property 
other than a capital asset, as defined in section 1221, shall be 
ordinary income if the transaction is between a partnership and a 
partner who owns, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in the partnership. This rule also 
applies where such a transaction is between partnerships in which the 
same persons own, directly or indirectly, more than 80 percent of the 
capital interest or profits interest in each partnership. The term 
property other than a capital asset includes (but is not limited to) 
trade accounts receivable, inventory, stock in trade, and depreciable or 
real property used in the trade or business.
    (3) Ownership of a capital or profits interest. In determining the 
extent of the ownership by a partner, as defined in section 761(b), of 
his capital interest or profits interest in a partnership, the rules for 
constructive ownership of stock provided in section 267(c) (1), (2), 
(4), and (5) shall be applied for the purpose of section 707(b) and this 
paragraph. Under these rules, ownership of a capital or profits interest 
in a partnership may be attributed to a person who is not a partner as 
defined in section 761(b) in order that another partner may be 
considered the constructive owner of such interest under section

[[Page 400]]

267(c). However, section 707(b)(1)(A) does not apply to a constructive 
owner of a partnership interest since he is not a partner as defined in 
section 761(b). For example, where trust T is a partner in the 
partnership ABT, and AW, A's wife, is the sole beneficiary of the trust, 
the ownership of a capital and profits interest in the partnership by T 
will be attributed to AW only for the purpose of further attributing the 
ownership of such interest to A. See section 267(c) (1) and (5). If A, 
B, and T are equal partners, then A will be considered as owning more 
than 50 percent of the capital and profits interest in the partnership, 
and losses on transactions between him and the partnership will be 
disallowed by section 707(b)(1)(A). However, a loss sustained by AW on a 
sale or exchange of property with the partnership would not be 
disallowed by section 707, but will be disallowed to the extent provided 
in paragraph (b) of Sec. 1.267(b)-1. See section 267 (a) and (b), and 
the regulations thereunder.
    (c) Guaranteed payments. Payments made by a partnership to a partner 
for services or for the use of capital are considered as made to a 
person who is not a partner, to the extent such payments are determined 
without regard to the income of the partnership. However, a partner must 
include such payments as ordinary income for his taxable year within or 
with which ends the partnership taxable year in which the partnership 
deducted such payments as paid or accrued under its method of 
accounting. See section 706(a) and paragraph (a) of Sec. 1.706-1. 
Guaranteed payments are considered as made to one who is not a member of 
the partnership only for the purposes of section 61(a) (relating to 
gross income) and section 162(a) (relating to trade or business 
expenses). For a guaranteed payment to be a partnership deduction, it 
must meet the same tests under section 162(a) as it would if the payment 
had been made to a person who is not a member of the partnership, and 
the rules of section 263 (relating to capital expenditures) must be 
taken into account. This rule does not affect the deductibility to the 
partnership of a payment described in section 736(a)(2) to a retiring 
partner or to a deceased partner's successor in interest. Guaranteed 
payments do not constitute an interest in partnership profits for 
purposes of sections 706(b)(3), 707(b), and 708(b). For the purposes of 
other provisions of the internal revenue laws, guaranteed payments are 
regarded as a partner's distributive share of ordinary income. Thus, a 
partner who receives guaranteed payments for a period during which he is 
absent from work because of personal injuries or sickness is not 
entitled to exclude such payments from his gross income under section 
105(d). Similarly, a partner who receives guaranteed payments is not 
regarded as an employee of the partnership for the purposes of 
withholding of tax at source, deferred compensation plans, etc. The 
provisions of this paragraph may be illustrated by the following 
examples:

    Example 1. Under the ABC partnership agreement, partner A is 
entitled to a fixed annual payment of $10,000 for services, without 
regard to the income of the partnership. His distributive share is 10 
percent. After deducting the guaranteed payment, the partnership has 
$50,000 ordinary income. A must include $15,000 as ordinary income for 
his taxable year within or with which the partnership taxable year ends 
($10,000 guaranteed payment plus $5,000 distributive share).
    Example 2. Partner C in the CD partnership is to receive 30 percent 
of partnership income as determined before taking into account any 
guaranteed payments, but not less than $10,000. The income of the 
partnership is $60,000, and C is entitled to $18,000 (30 percent of 
$60,000) as his distributive share. No part of this amount is a 
guaranteed payment. However, if the partnership had income of $20,000 
instead of $60,000, $6,000 (30 percent of $20,000) would be partner C's 
distributive share, and the remaining $4,000 payable to C would be a 
guaranteed payment.
    Example 3. Partner X in the XY partnership is to receive a payment 
of $10,000 for services, plus 30 percent of the taxable income or loss 
of the partnership. After deducting the payment of $10,000 to partner X, 
the XY partnership has a loss of $9,000. Of this amount, $2,700 (30 
percent of the loss) is X's distributive share of partnership loss and, 
subject to section 704(d), is to be taken into account by him in his 
return. In addition, he must report as ordinary income the guaranteed 
payment of $10,000 made to him by the partnership.
    Example 4. Assume the same facts as in example 3 of this paragraph, 
except that, instead of a $9,000 loss, the partnership has $30,000 in 
capital gains and no other items of income or deduction except the 
$10,000 paid X

[[Page 401]]

as a guaranteed payment. Since the items of partnership income or loss 
must be segregated under section 702(a), the partnership has a $10,000 
ordinary loss and $30,000 in capital gains. X's 30 percent distributive 
shares of these amounts are $3,000 ordinary loss and $9,000 capital 
gain. In addition, X has received a $10,000 guaranteed payment which is 
ordinary income to him.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7891, 48 FR 
20049, May 4, 1983]
Sec. 1.707-2  Disguised payments for services. [Reserved]



Sec. 1.707-3  Disguised sales of property to partnership; general rules.

    (a) Treatment of transfers as a sale--(1) In general. Except as 
otherwise provided in this section, if a transfer of property by a 
partner to a partnership and one or more transfers of money or other 
consideration by the partnership to that partner are described in 
paragraph (b)(1) of this section, the transfers are treated as a sale of 
property, in whole or in part, to the partnership.
    (2) Definition and timing of sale. For purposes of Secs. 1.707-3 
through 1.707-5, the use of the term sale (or any variation of that 
word) to refer to a transfer of property by a partner to a partnership 
and a transfer of consideration by a partnership to a partner means a 
sale or exchange of that property, in whole or in part, to the 
partnership by the partner acting in a capacity other than as a member 
of the partnership, rather than a contribution and distribution to which 
sections 721 and 731, respectively, apply. A transfer that is treated as 
a sale under paragraph (a)(1) this section is treated as a sale for all 
purposes of the Internal Revenue Code (e.g., sections 453, 483, 1001, 
1012, 1031 and 1274). The sale is considered to take place on the date 
that, under general principles of Federal tax law, the partnership is 
considered the owner of the property. If the transfer of money or other 
consideration from the partnership to the partner occurs after the 
transfer of property to the partnership; the partner and the partnership 
are treated as if, on the date of the sale, the partnership transferred 
to the partner an obligation to transfer to the partner money or other 
consideration.
    (3) Application of disguised sale rules. If a person purports to 
transfer property to a partnership in a capacity as a partner, the rules 
of this section apply for purposes of determining whether the property 
was transferred in a disguised sale, even if it is determined after the 
application of the rules of this section that such person is not a 
partner. If after the application of the rules of this section to a 
purported transfer of property to a partnership, it is determined that 
no partnership exists because the property was actually sold, or it is 
otherwise determined that the contributed property is not owned by the 
partnership for tax purposes, the transferor of the property is treated 
as having sold the property to the person (or persons) that acquired 
ownership of the property for tax purposes.
    (4) Deemed terminations under section 708. In applying the rules of 
this section, transfers resulting from a termination of a partnership 
under section 708(b)(1)(B) are disregarded.
    (b) Transfers treated as a sale--(1) In general. A transfer of 
property (excluding money or an obligation to contribute money) by a 
partner to a partnership and a transfer of money or other consideration 
(including the assumption of or the taking subject to a liability) by 
the partnership to the partner constitute a sale of property, in whole 
or in part, by the partner to the partnership only if based on all the 
facts and circumstances--
    (i) The transfer of money or other consideration would not have been 
made but for the transfer of property; and
    (ii) In cases in which the transfers are not made simultaneously, 
the subsequent transfer is not dependent on the entrepreneurial risks of 
partnership operations.
    (2) Facts and circumstances. The determination of whether a transfer 
of property by a partner to the partnership and a transfer of money or 
other consideration by the partnership to the partner constitute a sale, 
in whole or in part, under paragraph (b)(1) of this section is made 
based on all the facts and circumstances in each case. The weight to be 
given each of the facts and circumstances will depend on the particular 
case. Generally, the facts and

[[Page 402]]

circumstances existing on the date of the earliest of such transfers are 
the ones considered in determining whether a sale exists under paragraph 
(b)(1) of this section. Among the facts and circumstances that may tend 
to prove the existence of a sale under paragraph (b)(1) of this section 
are the following:
    (i) That the timing and amount of a subsequent transfer are 
determinable with reasonable certainty at the time of an earlier 
transfer;
    (ii) That the transferor has a legally enforceable right to the 
subsequent transfer;
    (iii) That the partner's right to receive the transfer of money or 
other consideration is secured in any manner, taking into account the 
period during which it is secured;
    (iv) That any person has made or is legally obligated to make 
contributions to the partnership in order to permit the partnership to 
make the transfer of money or other consideration;
    (v) That any person has loaned or has agreed to loan the partnership 
the money or other consideration required to enable the partnership to 
make the transfer, taking into account whether any such lending 
obligation is subject to contingencies related to the results of 
partnership operations;
    (vi) That a partnership has incurred or is obligated to incur debt 
to acquire the money or other consideration necessary to permit it to 
make the transfer, taking into account the likelihood that the 
partnership will be able to incur that debt (considering such factors as 
whether any person has agreed to guarantee or otherwise assume personal 
liability for that debt);
    (vii) That the partnership holds money or other liquid assets, 
beyond the reasonable needs of the business, that are expected to be 
available to make the transfer (taking into account the income that will 
be earned from those assets);
    (viii) That partnership distributions, allocation or control of 
partnership operations is designed to effect an exchange of the burdens 
and benefits of ownership of property;
    (ix) That the transfer of money or other consideration by the 
partnership to the partner is disproportionately large in relationship 
to the partner's general and continuing interest in partnership profits; 
and
    (x) That the partner has no obligation to return or repay the money 
or other consideration to the partnership, or has such an obligation but 
it is likely to become due at such a distant point in the future that 
the present value of that obligation is small in relation to the amount 
of money or other consideration transferred by the partnership to the 
partner.
    (c) Transfers made within two years presumed to be a sale--(1) In 
general. For purposes of this section, if within a two-year period a 
partner transfers property to a partnership and the partnership 
transfers money or other consideration to the partner (without regard to 
the order of the transfers), the transfers are presumed to be a sale of 
the property to the partnership unless the facts and circumstances 
clearly establish that the transfers do not constitute a sale.
    (2) Disclosure of transfers made within two years. Disclosure to the 
Internal Revenue Service in accordance with Sec. 1.707-8 is required 
if--
    (i) A partner transfers property to a partnership and the 
partnership transfers money or other consideration to the partner with a 
two-year period (without regard to the order of the transfers);
    (ii) The partner treats the transfers other than as a sale for tax 
purposes; and
    (iii) The transfer of money or other consideration to the partner is 
not presumed to be a guaranteed payment for capital under Sec. 1.707-
4(a)(1)(ii), is not a reasonable preferred return within the meaning of 
Sec. 1.707-4(a)(3), and is not an operating cash flow distribution 
within the meaning of Sec. 1.707-4(b)(2).
    (d) Transfers made more than two years apart presumed not to be a 
sale. For purposes of this section, if a transfer of money or other 
consideration to a partner by a partnership and the transfer of property 
to the partnership by that partner are more than two years apart, the 
transfers are presumed not to be a sale of the property to the 
partnership unless the facts and circumstances clearly establish that 
the transfers constitute a sale.

[[Page 403]]

    (e) Scope. This section and Sec. Sec. 1.707-4 through 1.707-9 apply 
to contributions and distributions of property described in section 
707(a)(2)(A) and transfers described in section 707(a)(2)(B) of the 
Internal Revenue Code.
    (f) Examples. The following examples illustrate the application of 
this section.

    Example 1. Treatment of simultaneous transfers as a sale. A 
transfers property X to partnership AB on April 9, 1992, in exchange for 
an interest in the partnership. At the time of the transfer, property X 
has a fair market value of $4,000,000 and an adjusted tax basis of 
$1,200,000. Immediately after the transfer, the partnership transfers 
$3,000,000 in cash to A. Assume that, under this section, the 
partnership's transfer of cash to A is treated as part of a sale of 
property X to the partnership. Because the amount of cash A receives on 
April 9, 1992, does not equal the fair market value of the property, A 
is considered to have sold a portion of property X with a value of 
$3,000,000 to the partnership in exchange for the cash. Accordingly, A 
must recognize $2,100,000 of gain ($3,000,000 amount realized less 
$900,000 adjusted tax basis ($1,200,000 multiplied by $3,000,000/
$4,000,000)). Assuming A receives no other transfers that are treated as 
consideration for the sale of the property under this section, A is 
considered to have contributed to the partnership, in A's capacity as a 
partner, $1,000,000 of the fair market value of the property with an 
adjusted tax basis of $300,000.
    Example 2. Treatment of transfers at different times as a sale. (i) 
The facts are the same as in Example 1, except that the $3,000,000 is 
transferred to A one year after A's transfer of property X to the 
partnership. Assume that under this section the partnership's transfer 
of cash to A is treated as part of a sale of property X to the 
partnership. Assume also that the applicable Federal short-term rate for 
April, 1992, is 10 percent, compounded semiannually.
    (ii) Under paragraph (a)(2) of this section, A and the partnership 
are treated as if, on April 9, 1992, A sold a portion of property X to 
the partnership in exchange for an obligation to transfer $3,000,000 to 
A one year later. Section 1274 applies to this obligation because it 
does not bear interest and is payable more than six months after the 
date of the sale. As a result, A's amount realized from the receipt of 
the partnership's obligation will be the imputed principal amount of the 
partnership's obligation to transfer $3,000,000 to A, which equals 
$2,721,088 (the present value on April 9, 1992, of a $3,000,000 payment 
due one year later, determined using a discount rate of 10 percent, 
compounded semiannually). Therefore, A's amount realized from the 
receipt of the partnership's obligation is $2,721,088 (without regard to 
whether the sale is reported under the installment method). A is 
therefore considered to have sold only $2,721,088 of the fair market 
value of property X. The remainder of the $3,000,000 payment ($278,912) 
is characterized in accordance with the provisions of section 1272. 
Accordingly, A must recognize $1,904,761 of gain ($2,721,088 amount 
realized less $816,327 adjusted tax basis ($1,200,000 multiplied by 
$2,721,088/$4,000,000)) on the sale of property X to the partnership. 
The gain is reportable under the installment method of section 453 if 
the sale is otherwise eligible. Assuming A receives no other transfers 
that are treated as consideration for the sale of property under this 
section, A is considered to have contributed to the partnership, in A's 
capacity as a partner, $1,278,912 of the fair market value of property X 
with an adjusted tax basis of $383,673.
    Example 3. Operation of presumption for transfers within two years. 
(i) C transfers undeveloped land to the CD partnership in exchange for 
an interest in the partnership. The partnership intends to construct a 
building on the land. At the time the land is transferred to the 
partnership, it is unencumbered and has an adjusted tax basis of 
$500,000 and a fair market value of $1,000,000. The partnership 
agreement provides that upon completing construction of the building the 
partnership will distribute $900,000 to C.
    (ii) If, within two years of C's transfer of land to the 
partnership, a transfer is made to C pursuant to the provision requiring 
a distribution upon completion of the building, the transfer is presumed 
to be, under paragraph (c) of this section, part of a sale of the land 
to the partnership. C may rebut the presumption that the transfer is 
part of a sale if the facts and circumstances clearly establish that--
    (A) The transfer to C would have been made without regard to C's 
transfer of land to the partnership; or
    (B) The partnership's obligation or ability to make this transfer to 
C depends, at the time of the transfer to the partnership, on the 
entrepreneurial risks of partnership operations.
    (iii) For example, if the partnership will be able to fund the 
transfer of cash to C only to the extent that permanent loan proceeds 
exceed the cost of constructing the building, the fact that excess 
permanent loan proceeds will be available only if the cost to complete 
the building is significantly less than the amount projected by a 
reasonable budget would be evidence that the transfer to C is not part 
of a sale. Similarly, a condition that limits the amount of the 
permanent loan to the cost of constructing the building (and thereby 
limits the partnership's ability to make a transfer to C) unless all or 
a substantial portion of the building is leased

[[Page 404]]

would be evidence that the transfer to C is not part of a sale, if a 
significant risk exists that the partnership may not be able to lease 
the building to that extent. Another factor that may prove that the 
transfer of cash to C is not part of a sale would be that, at the time 
the land is transferred to the partnership, no lender has committed to 
make a permanent loan to fund the transfer of cash to C.
    (iv) Facts indicating that the transfer of cash to C is not part of 
a sale, however, may be offset by other factors. An offsetting factor to 
restrictions on the permanent loan proceeds may be that the permanent 
loan is to be a recourse loan and certain conditions to the loan are 
likely to be waived by the lender because of the creditworthiness of the 
partners or the value of the partnership's other assets. Similarly, the 
factor that no lender has committed to fund the transfer of cash to C 
may be offset by facts establishing that the partnership is obligated to 
attempt to obtain such a loan and that its ability to obtain such a loan 
is not significantly dependent on the value that will be added by 
successful completion of the building, or that the partnership 
reasonably anticipates that it will have (and will utilize) an 
alternative source to fund the transfer of cash to C if the permanent 
loan proceeds are inadequate.
    Example 4. Operation of presumption for transfers within two years. 
E is a partner in the equal EF partnership. The partnership owns two 
parcels of unimproved real property (parcels 1 and 2). Parcels 1 and 2 
are unencumbered. Parcel 1 has a fair market value of $500,000, and 
parcel 2 has a fair market value of $1,500,000. E transfers additional 
unencumbered, unimproved real property (parcel 3) with a fair market 
value of $1,000,000 to the partnership in exchange for an increased 
interest in partnership profits of 66\2/3\ percent. Immediately after 
this transfer, the partnership sells parcel 1 for $500,000 in a 
transaction not in the ordinary course of business. The partnership 
transfers the proceeds of the sale $333,333 to E and $166,667 to F in 
accordance with their respective partnership interests. The transfer of 
$333,333 to E is presumed to be, in accordance with paragraph (c) of 
this section, a sale, in part, of parcel 3 to the partnership. However, 
the facts of this example clearly establish that $250,000 of the 
transfer to E is not part of a sale of parcel 3 to the partnership 
because E would have been distributed $250,000 from the sale of parcel 1 
whether or not E had transferred parcel 3 to the partnership. The 
transfer to E exceeds by $83,333 ($333,333 minus $250,000) the amount of 
the distribution that would have been made to E if E had not transferred 
parcel 3 to the partnership. Therefore, $83,333 of the transfer is 
presumed to be part of a sale of a portion of parcel 3 to the 
partnership by E.
    Example 5. Operation of presumption for transfers more than two 
years apart. (i) G transfers undeveloped land to the GH partnership in 
exchange for an interest in the partnership. At the time the land is 
transferred to the partnership, it is unencumbered and has an adjusted 
tax basis of $500,000 and a fair market value of $1,000,000. H 
contributes $1,000,000 in cash in exchange for an interest in the 
partnership. Under the partnership agreement, the partnership is 
obligated to construct a building on the land. The projected 
construction cost is $5,000,000, which the partnership plans to fund 
with its $1,000,000 in cash and the proceeds of a construction loan 
secured by the land and improvements.
    (ii) Shortly before G's transfer of the land to the partnership, the 
partnership secures commitments from lending institutions for 
construction and permanent financing. To obtain the construction loan, H 
guarantees completion of the building for a cost of $5,000,000. The 
partnership is not obligated to reimburse or indemnify H if H must make 
payment on the completion guarantee. The permanent loan will be funded 
upon completion of the building, which is expected to occur two years 
after G's transfer of the land. The amount of the permanent loan is to 
equal the lesser of $5,000,000 or 80 percent of the appraised value of 
the improved property at the time the permanent loan is closed. Under 
the partnership agreement, the partnership is obligated to apply the 
proceeds of the permanent loan to retire the construction loan and to 
hold any excess proceeds for transfer to G 25 months after G's transfer 
of the land to the partnership. The appraised value of the improved 
property at the time the permanent loan is closed is expected to exceed 
$5,000,000 only if the partnership is able to lease a substantial 
portion of the improvements by that time, and there is a significant 
risk that the partnership will not be able to achieve a satisfactory 
occupancy level. The partnership completes construction of the building 
for the projected cost of $5,000,000 approximately two years after G's 
transfer of the land. Shortly thereafter, the permanent loan is funded 
in the amount of $5,000,000. At the time of funding the land and 
building have an appraised value of $7,000,000. The partnership 
transfers the $1,000,000 excess permanent loan proceeds to G 25 months 
after G's transfer of the land to the partnership.
    (iii) G's transfer of the land to the partnership and the 
partnership's transfer of $1,000,000 to G occurred more than two years 
apart. In accordance with paragraph (d) of this section, those transfers 
are presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale of the property, in whole 
or part, to the partnership. The transfer of $1,000,000 to G would not 
have been

[[Page 405]]

made but for G's transfer of the land to the partnership. In addition, 
at the time G transferred the land to the partnership, G had a legally 
enforceable right to receive a transfer from the partnership at a 
specified time an amount that equals the excess of the permanent loan 
proceeds over $4,000,000. In this case, however, there was a significant 
risk that the appraised value of the property would be insufficient to 
support a permanent loan in excess of $4,000,000 because of the risk 
that the partnership would not be able to achieve a sufficient occupancy 
level. Therefore, the facts of this example indicate that at the time G 
transferred the land to the partnership the subsequent transfer of 
$1,000,000 to G depended on the entrepreneurial risks of partnership 
operations. Accordingly, G's transfer of the land to the partnership is 
not treated as part of a sale.
    Example 6. Rebuttal of presumption for transfers more than two years 
apart. The facts are the same as in Example 5, except that the 
partnership is able to secure a commitment for a permanent loan in the 
amount of $5,000,000 without regard to the appraised value of the 
improved property at the time the permanent loan is funded. Under these 
facts, at the time that G transferred the land to the partnership the 
subsequent transfer of $1,000,000 to G was not dependent on the 
entrepreneurial risks of partnership operations, because during the 
period before the permanent loan is funded, the permanent lender's 
obligation to make a loan in the amount necessary to fund the transfer 
is not subject to the contingencies related to the risks of partnership 
operations, and after the permanent loan is funded, the partnership 
holds liquid assets sufficient to make the transfer. Therefore, the 
facts and circumstances clearly establish that G's transfer of the land 
to the partnership is part of a sale.
    Example 7. Operation of presumption for transfers more than two 
years apart. The facts are the same as in Example 6, except that H does 
not guarantee either that the improvements will be completed or that the 
cost to the partnership of completing the improvements will not exceed 
$5,000,000. Under these facts, if there is a significant risk that the 
improvements will not be completed, G's transfer of the land to the 
partnership will not be treated as part of a sale because the lender is 
required to make the permanent loan if the improvements are not 
completed. Similarly, the transfers will not be treated as a sale to the 
extent that there is a significant risk that the cost of constructing 
the improvements will exceed $5,000,000, because, in the absence of a 
guarantee of the cost of the improvements by H, the $5,000,000 proceeds 
of the permanent loan might not be sufficient to retire the construction 
loan and fund the transfer to G. In either case, the transfer of cash to 
G would be dependent on the entrepreneurial risks of partnership 
operations.
    Example 8. Rebuttal of presumption for transfers more than two years 
apart. (i) On February 1, 1992, I, J, and K form partnership IJK. On 
formation of the partnership, I transfers an unencumbered office 
building with a fair market value of $50,000,000 and an adjusted tax 
basis of $20,000,000 to the partnership, and J and K each transfer 
United States government securities with a fair market value and an 
adjusted tax basis of $25,000,000 to the partnership. Substantially all 
of the rentable space in the office building is leased on a long-term 
basis. The partnership agreement provides that all items of income, 
gain, loss, and deduction from the office building are to be allocated 
45 percent to J, 45 percent to K, and 10 percent to I. The partnership 
agreement also provides that all items of income, gain, loss, and 
deduction from the government securities are to be allocated 90 percent 
to I, 5 percent to J, and 5 percent to K. The partnership agreement 
requires that cash flow from the office building and government 
securities be allocated between partners in the same manner as the items 
of income, gain, loss, and deduction from those properties are allocated 
between them. The partnership agreement complies with the requirements 
of Sec. 1.704-1(b)(2)(ii)(b). It is not expected that the partnership 
will need to resort to the government securities or the cash flow 
therefrom to operate the office building. At the time the partnership is 
formed, I, J, and K contemplated that I's interest in the partnership 
would be liquidated sometime after January 31, 1994, in exchange for a 
transfer of the government securities and cash (if necessary). On March 
1, 1995, the partnership transfers cash and the government securities to 
I in liquidation of I's interest in the partnership. The cash 
transferred to I represents the excess of I's share of the appreciation 
in the office building since the formation of the partnership over J's 
and K's share of the appreciation in the government securities since 
they are acquired by the partnership.
    (ii) I's transfer of the office building to the partnership and the 
partnership's transfer of the government securities and cash to I 
occurred more than two years apart. Therefore, those transfers are 
presumed not to be a sale unless the facts and circumstances clearly 
establish that the transfers constitute a sale. Absent I's transfer of 
the office building to the (partnership, I would not have received the 
government securities from the partnership. The facts including the 
amount and nature of partnership assets) indicate that, at the time that 
I transferred the office building to the partnership, the timing of the 
transfer of the government securities to I was anticipated and was not 
dependent on the entrepreneurial risks of partnership operations. 
Moreover, the facts indicate that

[[Page 406]]

the partnership allocations were designed to effect an exchange of the 
burdens and benefits of ownership of the government securities in 
anticipation of the transfer of those securities to I and those burdens 
and benefits were effectively shifted to I on formation of the 
partnership. Accordingly, the facts and circumstances clearly establish 
that I sold the office building to the partnership on February 1, 1992, 
in exchange for the partnership's obligation to transfer the government 
securities to I and to make certain other cash transfers to I.

[T.D. 8439, 57 FR 44978, Sept. 30, 1992]



Sec. 1.707-4  Disguised sales of property to partnership; special rules applicable to guaranteed payments, preferred returns, operating cash flow distributions, 
          and reimbursements of preformation expenditures.

    (a) Guaranteed payments and preferred returns--(1) Guaranteed 
payment not treated as part of a sale--(i) In general. A guaranteed 
payment for capital made to a partner is not treated as part of a sale 
of property under Sec. 1.707-3(a) (relating to treatment of transfers as 
a sale). A party's characterization of a payment as a guaranteed payment 
for capital will not control in determining whether a payment is, in 
fact, a guaranteed payment for capital. The term guaranteed payment for 
capital means any payment to a partner by a partnership that is 
determined without regard to partnership income and is for the use of 
that partner's capital. See section 707(c). For this purpose, one or 
more payments are not made for the use of a partner's capital if the 
payments are designed to liquidate all or part of the partner's interest 
in property contributed to the partnership rather than to provide the 
partner with a return on an investment in the partnership.
    (ii) Reasonable guaranteed payments. Notwithstanding the presumption 
set forth in Sec. 1.707-3(c) (relating to transfers made within two 
years of each other), for purposes of section 707(a)(2) and the 
regulations thereunder a transfer of money to a partner that is 
characterized by the parties as a guaranteed payment for capital, is 
determined without regard to the income of the partnership and is 
reasonable (within the meaning of paragraph (a)(3) of this section) is 
presumed to be a guaranteed payment for capital unless the facts and 
circumstances clearly establish that the transfer is not a guaranteed 
payment for capital and is part of a sale.
    (iii) Unreasonable guaranteed payments. A transfer of money to a 
partner that is characterized by the parties as a guaranteed payment for 
capital but that is not reasonable (within the meaning of paragraph 
(a)(3) of this section) is presumed not to be a guaranteed payment for 
capital unless the facts and circumstances clearly establish that the 
transfer is a guaranteed payment for capital. A transfer that is not a 
guaranteed payment for capital is subject to the rules of Sec. 1.707-3.
    (2) Presumption regarding reasonable preferred returns. 
Notwithstanding the presumption set forth in Sec. 1.707-3(c) (relating 
to transfers made within two years of each other), a transfer of money 
to a partner that is characterized by the parties as a preferred return 
and that is reasonable (within the meaning of paragraph (a)(3) of this 
section) is presumed not to be part of a sale of property to the 
partnership unless the facts and circumstances (including the likelihood 
and expected timing of the subsequent allocation of income or gain to 
support the preferred return) clearly establish that the transfer is 
part of a sale. The term preferred return means a preferential 
distribution of partnership cash flow to a partner with respect to 
capital contributed to the partnership by the partner that will be 
matched, to the extent available, by an allocation of income or gain.
    (3) Definition of reasonable preferred returns and guaranteed 
payments--(i) In general. A transfer of money to a partner that is 
characterized as a preferred return or guaranteed payment for capital is 
reasonable only to the extent that the transfer is made to the partner 
pursuant to a written provision of a partnership agreement that provides 
for payment for the use of capital in a reasonable amount, and only to 
the extent that the payment is made for the use of capital after the 
date on which that provision is added to the partnership agreement.
    (ii) Reasonable amount. A transfer of money that is made to a 
partner during any partnership taxable year and is

[[Page 407]]

characterized as a preferred return or guaranteed payment for capital is 
reasonable in amount if the sum of any preferred return and any 
guaranteed payment for capital that is payable for that year does not 
exceed the amount determined by multiplying either the partner's 
unreturned capital at the beginning of the year or, at the partner's 
option, the partner's weighted average capital balance for the year 
(with either amount appropriately adjusted, taking into account the 
relevant compounding periods, to reflect any unpaid preferred return or 
guaranteed payment for capital that is payable to the partner) by the 
safe harbor interest rate for that year. The safe harbor interest rate 
for a partnership's taxable year equals 150 percent of the highest 
applicable Federal rate, at the appropriate compounding period or 
periods, in effect at any time from the time that the right to the 
preferred return or guaranteed payment for capital is first established 
pursuant to a binding, written agreement among the partners through the 
end of the taxable year. A partner's unreturned capital equals the 
excess of the aggregate amount of money and the fair market value of 
other consideration (net of liabilities) contributed by the partner to 
the partnership over the aggregate amount of money and the fair market 
value of other consideration (net of liabilities) distributed by the 
partnership to the partner other than transfers of money that are 
presumed to be guaranteed payments for capital under paragraph 
(a)(1)(ii) of this section, transfers of money that are reasonable 
preferred returns within the meaning of this paragraph (a)(3), and 
operating cash flow distributions within the meaning of paragraph (b)(2) 
of this section.
    (4) Examples. The following examples illustrate the application of 
paragraph (a) of this section:

    Example 1. Transfer presumed to be a guaranteed payment. (i) A 
transfers property with a fair market value of $100,000 to partnership 
AB. At the time of A's transfer, the partnership agreement is amended to 
provide that A is to receive a guaranteed payment for the use of A's 
capital of 10 percent (compounded annually) of the fair market value of 
the transferred property in each of the three years following the 
transfer. The partnership agreement provides that partnership net 
taxable income and loss will be allocated equally between partners A and 
B, and that partnership cash flow will be distributed in accordance with 
the allocation of partnership net taxable income and loss. The 
partnership would be allowed a deduction in the year paid if the 
transfers made to A are treated as guaranteed payments under section 
707(c). Under the partnership agreement, that deduction would be 
allocated in the same manner as any other item of partnership deduction. 
The partnership agreement complies with the requirements of Sec. 1.704-
1(b)(2)(ii)(b). The partnership agreement does not provide for the 
payment of a preferred return and, other than the guaranteed payment to 
be paid to A, no transfer is expected to be made during the three year 
period following A's transfer that is not an operating cash flow 
distribution (within the meaning of paragraph (b)(2) of this section). 
Assume that the highest applicable Federal rate in effect at the time of 
A's transfer is eight percent compounded annually.
    (ii) The transfer of money to be made to A under the partnership 
agreement is characterized by the parties as a guaranteed payment for 
capital and is determined without regard to the income of the 
partnership. The transfer is also reasonable within the meaning of 
Sec. 1.707-4(a)(3). The transfer, therefore, is presumed to be a 
guaranteed payment for capital. The presumption set forth in Sec. 1.707-
3(c) (relating to transfers made within two years of each other) thus 
does not apply to this transfer. The transfer will not be treated as 
part of a sale of property to the partnership unless the facts and 
circumstances clearly establish that the transfer is not a guaranteed 
payment for capital but is part of a sale.
    (iii) The presumption that the transfer is a guaranteed payment for 
capital is not rebutted, because there are no facts indicating that the 
transfer is not a guaranteed payment for the use of capital.
    Example 2. Transfers characterized as guaranteed payments treated as 
part of a sale. (i) C and D form partnership CD. C transfers property 
with a fair market value of $100,000 and an adjusted tax basis of 
$20,000 in exchange for a partnership interest. D is responsible for 
managing the day-to-day operations of the partnership and makes no 
capital contribution to the partnership upon its formation. The 
partnership agreement provides that C is to receive payments 
characterized as guaranteed payments and determined without regard to 
partnership income of $8,333 per year for the first four years of 
partnership operations for the use of C's capital. In addition, the 
partnership agreement provides that--
    (A) Partnership net taxable income and loss will be allocated 75 
percent to C and 25 percent to D; and

[[Page 408]]

    (B) All partnership cash flow (determined prior to consideration of 
the guaranteed payment) will be distributed 75 percent to C and 25 
percent to D except that guaranteed payments that the partnership is 
obligated to make to C are payable solely out of D's share of the 
partnership's cash flow.
    (ii) If D's share of the partnership's cash flow is not sufficient 
to make the guaranteed payment to C, then D is obligated to contribute 
any shortfall to the partnership, even in the event the partnership is 
liquidated. Thus, the effect of the guaranteed payment arrangement is 
that the guaranteed payment to C is funded entirely by D. The 
partnership agreement complies with the requirements of Sec. 1.704-
1(b)(2)(ii)(b). Assume that, at the time the partnership is formed, the 
partnership or D could borrow $25,000 pursuant to a loan requiring equal 
payments of principal and interest over a four-year term at the current 
market interest rate of approximately 12 percent (compounded annually). 
Assume that the highest applicable Federal rate in effect at the time 
the partnership is formed is 10 percent compounded annually.
    (iii) The transfer of money to be made to C under the partnership 
agreement is characterized by the parties as a guaranteed payment for 
capital and is determined without regard to the income of the 
partnership. The transfer is also reasonable within the meaning of 
Sec. 1.707-4(a)(3). The transfer, therefore, is presumed to be a 
guaranteed payment for capital. The presumption set forth in Sec. 1.707-
3(c) (relating to transfers made within two years of each other) thus 
does not apply to this transfer. The transfer will not be treated as 
part of a sale of property to the partnership unless the facts and 
circumstances clearly establish that the transfer is not a guaranteed 
payment for capital and is part of a sale.
    (iv) For the first four years of partnership operations, the total 
guaranteed payments made to C under the partnership agreement will equal 
$33,332. If the characterization of those payments as guaranteed 
payments for capital within the meaning of section 707(c) were 
respected, C would be allocated $24,999 of the deductions that would be 
claimed by the partnership for those payments, thereby leaving the 
balance in C's capital account approximately $25,000 less than it would 
have been if the guaranteed payments had not been made. The guaranteed 
payments thus have the effect of offsetting approximately $25,000 of the 
credit made to C's capital account for the property transferred to the 
partnership by C. C's resulting capital account is approximately 
equivalent to the capital account C would have had if C had only 
contributed 75 percent of the property to the partnership. Furthermore, 
the effect of D's funding the guaranteed payment to C (either through 
reduced distributions of cash flow to D or additional contributions) is 
that D's capital account is approximately equivalent to the capital 
account D would have had if D had contributed 25 percent of the property 
(or contributed cash so that the partnership could purchase the 25 
percent). Moreover, a $25,000 loan requiring equal payments of principal 
and interest over a four-year term at the current market interest rate 
of 12 percent (compounded annually), would have resulted in annual 
payments of principal and interest of $8,230.86. Consequently, the 
guaranteed payments effectively place the partners in the same economic 
position that they would have been in had D purchased a one-quarter 
interest in the property from C financed at the current market rate of 
interest, and then C and D each contributed their share of the property 
to the partnership. In view of the burden the guaranteed payments place 
on D's right to transfers of partnership cash flow and D's legal 
obligation to make contributions to the partnership to the extent 
necessary to fund the guaranteed payments, D has effectively purchased 
through the partnership a one-quarter interest in the property from C.
    (v) Under these facts, the presumption that the transfers to C are 
guaranteed payments for capital is rebutted, because the facts and 
circumstances clearly establish that the transfers are part of a sale 
and not guaranteed payments for capital. Under Sec. 1.707-3(a), C and 
the partnership are treated as if C sold a one-quarter interest in the 
property to the partnership in exchange for a promissory note evidencing 
the partnership's obligation to make the guaranteed payments.

    (b) Presumption regarding operating cash flow distributions--(1) In 
general. Notwithstanding the presumption set forth in Sec. 1.707-3(c) 
(relating to transfers made within two years of each other), an 
operating cash flow distribution is presumed not to be part of a sale of 
property to the partnership unless the facts and circumstances clearly 
establish that the transfer is part of a sale.
    (2) Operating cash flow distributions--(i) In general. One or more 
transfers of money by the partnership to a partner during a taxable year 
of the partnership are operating cash flow distributions for purposes of 
paragraph (b)(1) of this section to the extent that those transfers are 
not presumed to be guaranteed payments for capital under paragraph 
(a)(1)(ii) of this section, are not reasonable preferred returns within 
the meaning of paragraph (a)(3) of this section, are not characterized 
by the parties as distributions to the partner acting in a capacity 
other than as a

[[Page 409]]

partner, and to the extent they do not exceed the product of the net 
cash flow of the partnership from operations for the year multiplied by 
the lesser of the partner's percentage interest in overall partnership 
profits for that year or the partner's percentage interest in overall 
partnership profits for the life of the partnership. For purposes of the 
preceding sentence, the net cash flow of the partnership from operations 
for a taxable year is an amount equal to the taxable income or loss of 
the partnership arising in the ordinary course of the partnership's 
business and investment activities, increased by tax exempt interest, 
depreciation, amortization, cost recovery allowances and other noncash 
charges deducted in determining such taxable income and decreased by--
    (A) Principal payments made on any partnership indebtedness;
    (B) Property replacement or contingency reserves actually 
established by the partnership;
    (C) Capital expenditures when made other than from reserves or from 
borrowings the proceeds of which are not included in operating cash 
flow; and
    (D) Any other cash expenditures (including preferred returns) not 
deducted in determining such taxable income or loss.
    (ii) Operating cash flow safe harbor. For any taxable year, in 
determining a partner's operating cash flow distributions for the year, 
the partner may use the partner's smallest percentage interest under the 
terms of the partnership agreement in any material item of partnership 
income or gain that may be realized by the partnership in the three-year 
period beginning with such taxable year. This provision is merely 
intended to provide taxpayers with a safe harbor and is not intended to 
preclude a taxpayer from using a different percentage under the rules of 
paragraph (b)(2)(i) of this section.
    (iii) Tiered partnerships. In the case of tiered partnerships, the 
upper-tier partnership must take into account its share of the net cash 
flow from operations of the lower-tier partnership applying principles 
similar to those described in paragraph (b)(2)(i) of this section, so 
that the amount of the upper-tier partnership's operating cash flow 
distributions is neither overstated nor understated.
    (c) Accumulation of guaranteed payments, preferred returns, and 
operating cash flow distributions. Guaranteed payments for capital, 
preferred returns, and operating cash flow distributions presumed not to 
be part of a sale under the rules of paragraphs (a) and (b) of this 
section do not lose the benefit of the presumption by reason of being 
retained for distribution in a later year.
    (d) Exception for reimbursements of preformation expenditures. A 
transfer of money or other consideration by the partnership to a partner 
is not treated as part of a sale of property by the partner to the 
partnership under Sec. 1.707-3(a) (relating to treatment of transfers as 
a sale) to the extent that the transfer to the partner by the 
partnership is made to reimburse the partner for, and does not exceed 
the amount of, capital expenditures that--
    (1) Are incurred during the two-year period preceding the transfer 
by the partner to the partnership; and
    (2) Are incurred by the partner with respect to--
    (i) Partnership organization and syndication costs described in 
section 709; or
    (ii) Property contributed to the partnership by the partner, but 
only to the extent the reimbursed capital expenditures do not exceed 20 
percent of the fair market value of such property at the time of the 
contribution. However, the 20 percent of fair market value limitation of 
this paragraph (d)(2)(ii) does not apply if the fair market value of the 
contributed property does not exceed 120 percent of the partner's 
adjusted basis in the contributed property at the time of contribution.
    (e) Other exceptions. The Commissioner may provide by guidance 
published in the Internal Revenue Bulletin that other payments or 
transfers to a partner are not treated as part of a sale for purposes of 
section 707(a)(2) and the regulations thereunder.

[T.D. 8439, 57 FR 44981, Sept. 30, 1992; 57 FR 56444, Nov. 30, 1992]

[[Page 410]]



Sec. 1.707-5  Disguised sales of property to partnership; special rules relating to liabilities.

    (a) Liability assumed or taken subject to by partnership--(1) In 
general. For purposes of this section and Secs. 1.707-3 and 1.707-4, if 
a partnership assumes or takes property subject to a qualified liability 
(as defined in paragraph (a)(6) of this section) of a partner, the 
partnership is treated as transferring consideration to the partner only 
to the extent provided in paragraph (a)(5) of this section. By contrast, 
if the partnership assumes or takes property subject to a liability of 
the partner other than a qualified liability, the partnership is treated 
as transferring consideration to the partner to the extent that the 
amount of the liability exceeds the partner's share of that liability 
immediately after the partnership assumes or takes subject to the 
liability as provided in paragraphs (a) (2), (3) and (4) of this 
section.
    (2) Partner's share of liability. A partner's share of any liability 
of the partnership is determined under the following rules:
    (i) Recourse liability. A partner's share of a recourse liability of 
the partnership equals the partner's share of the liability under the 
rules of section 752 and the regulations thereunder. A partnership 
liability is a recourse liability to the extent that the obligation is a 
recourse liability under Sec. 1.752-1(a)(1) or would be treated as a 
recourse liability under that section if it were treated as a 
partnership liability for purposes of that section.
    (ii) Nonrecourse liability. A partner's share of a nonrecourse 
liability of the partnership is determined by applying the same 
percentage used to determine the partner's share of the excess 
nonrecourse liability under Sec. 1.752-3(a)(3). A partnership liability 
is a nonrecourse liability of the partnership to the extent that the 
obligation is a nonrecourse liability under Sec. 1.752-1(a)(2) or would 
be a nonrecourse liability of the partnership under Sec. 1.752-1(a)(2) 
if it were treated as a partnership liability for purposes of that 
section.
    (3) Reduction of partner's share of liability. For purposes of this 
section, a partner's share of a liability, immediately after a 
partnership assumes or takes subject to the liability, is determined by 
taking into account a subsequent reduction in the partner's share if--
    (i) At the time that the partnership assumes or takes subject to a 
liability, it is anticipated that the transferring partner's share of 
the liability will be subsequently reduced; and
    (ii) The reduction of the partner's share of the liability is part 
of a plan that has as one of its principal purposes minimizing the 
extent to which the assumption of or taking subject to the liability is 
treated as part of a sale under Sec. 1.707-3.
    (4) Special rule applicable to transfers of encumbered property to a 
partnership by more than one partner pursuant to a plan. For purposes of 
paragraph (a)(1) of this section, if the partnership assumes or takes 
property or properties subject to the liabilities of more than one 
partner pursuant to a plan, a partner's share of the liabilities assumed 
or taken subject to by the partnership pursuant to that plan immediately 
after the transfers equals the sum of that partner's shares of the 
liabilities (other than that partner's qualified liabilities, as defined 
in paragraph (a)(6) of this section) assumed or taken subject to by the 
partnership pursuant to the plan. This paragraph (a)(4) does not apply 
to any liability assumed or taken subject to by the partnership with a 
principal purpose of reducing the extent to which any other liability 
assumed or taken subject to by the partnership is treated as a transfer 
of consideration under paragraph (a)(1) of this section.
    (5) Special rule applicable to qualified liabilities. (i) If a 
transfer of property by a partner to a partnership is not otherwise 
treated as part of a sale, the partnership's assumption of or taking 
subject to a qualified liability in connection with a transfer of 
property is not treated as part of a sale. If a transfer of property by 
a partner to the partnership is treated as part of a sale without regard 
to the partnership's assumption of or taking subject to a qualified 
liability (as defined in paragraph (a)(6) of this section) in connection 
with the transfer of property, the partnership's assumption of or taking 
subject to that

[[Page 411]]

liability is treated as a transfer of consideration made pursuant to a 
sale of such property to the partnership only to the extent of the 
lesser of--
    (A) The amount of consideration that the partnership would be 
treated as transferring to the partner under paragraph (a)(1) of this 
section if the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the amount of the qualified 
liability by the partner's net equity percentage with respect to that 
property.
    (ii) A partner's net equity percentage with respect to an item of 
property equals the percentage determined by dividing--
    (A) The aggregate transfers of money or other consideration to the 
partner by the partnership (other than any transfer described in this 
paragraph (a)(5)) that are treated as proceeds realized from the sale of 
the transferred property; by
    (B) The excess of the fair market value of the property at the time 
it is transferred to the partnership over any qualified liability 
encumbering the property or, in the case of any qualified liability 
described in paragraph (a)(6)(i) (C) or (D) of this section, that is 
properly allocable to the property.
    (6) Qualified liability of a partner defined. A liability assumed or 
taken subject to by a partnership in connection with a transfer of 
property to the partnership by a partner is qualified liability of the 
partner only to the extend--
    (i) The liability is--
    (A) A liability that was incurred by the partner more than two years 
prior to the earlier of the date the partner agrees in writing to 
transfers the property or the date the partner transfers the property to 
the partnership and that has encumbered the transferred property 
throughout that two-year period;
    (B) A liability that was not incurred in anticipation of the 
transfer of the property to a partnership, buy that was incurred by the 
partner within the two-year period prior to the earlier of the date the 
partner agrees in writing to transfer the property or the date the 
partner transfers the property to the partnership and that has 
encumbered the transferred property since it was incurred (see paragraph 
(a)(7) of this section for further rules regarding a liability incurred 
within two years of a property transfer or of a written agreement to 
transfer);
    (C) A liability that is allocable under the rules of Sec. 1.163-8T 
to capital expenditures with respect to the property; or
    (D) A liability that was incurred in the ordinary course of the 
trade or business in which property transferred to the partnership was 
used or held but only if all the assets related to that trade or 
business are transferred other than assets that are not material to a 
continuation of the trade or business; and
    (ii) If the liability is a recourse liability, the amount of the 
liability does not exceed the fair market value of the transferred 
property (less the amount of any other liabilities that are senior in 
priority and that either encumber such property or are liabilities 
described in paragraph (a)(6)(i) (C) or (D) of this section) at the time 
of the transfer.
    (7) Liability incurred within two years of transfer presumed to be 
in anticipation of the transfer--(i) In general. For purposes of this 
section, if within a two-year period a partner incurs a liability (other 
than a liability described in paragraph (a)(6)(i) (C) or (D) of this 
section) and transfers property to a partnership or agrees in writing to 
transfer the property, and in connection with the transfer the 
partnership assumes or takes the property subject to the liability, the 
liability is presumed to be incurred in anticipation of the transfer 
unless the facts and circumstances clearly establish that the liability 
was not incurred in anticipation of the transfer.
    (ii) Disclosure of transfers of property subject to liabilities 
incurred within two years of the transfer. If a partner treats a 
liability assumed or taken subject to by a partnership as a qualified 
liability under paragraph (a)(6)(i)(B) of this section, such treatment 
is to be disclosed to the Internal Revenue Service in accordance with 
Sec. 1.707-8.
    (b) Treatment of debt-financed transfers of consideration by 
partnerships--(1) In general. For purposes of Sec. 1.707-3, if a partner 
transfers property to a partnership, and the partnership incurs a

[[Page 412]]

liability and all or a portion of the proceeds of that liability are 
allocable under Sec. 1.163-8T to a transfer of money or other 
consideration to the partner made within 90 days of incurring the 
liability, the transfer of money or other consideration to the partner 
is taken into account only to the extent that the amount of money or the 
fair market value of the other consideration transferred exceeds that 
partner's allocable share of the partnership liability.
    (2) Partner's allocable share of liability--(i) In general. A 
partner's allocable share of a partnership liability for purposes of 
paragraph (b)(1) of this section equals the amount obtained by 
multiplying the partner's share of the liability as described in 
paragraph (a)(2) of this section by the fraction determined by 
dividing--
    (A) The portion of the liability that is allocable under Sec. 1.163-
8T to the money or other property transferred to the partner; by
    (B) The total amount of the liability.
    (ii) Debt-financed transfers made pursuant to a plan--(A) In 
general. Except as provided in paragraph (b)(2)(iii) of this section, if 
a partnership transfers to more than one partner pursuant to a plan all 
or a portion of the proceeds of one or more partnership liabilities, 
paragraph (b)(1) of this section is applied by treating all of the 
liabilities incurred pursuant to the plan as one liability, and each 
partner's allocable share of those liabilities equals the amount 
obtained by multiplying the sum of the partner's shares of each of the 
respective liabilities (as defined in paragraph (a)(2) of this section) 
by the fraction obtained by dividing--
    (1) The portion of those liabilities that is allocable under 
Sec. 1.163-8T to the money or other consideration transferred to the 
partners pursuant to the plan; by
    (2) The total amount of those liabilities.
    (B) Special rule. Paragraph (b)(2)(ii)(A) of this section does not 
apply to any transfer of money or other property to a partner that is 
made with a principal purpose of reducing the extent to which any 
transfer is taken into account under paragraph (b)(1) of this section.
    (iii) Reduction of partner's share of liability. For purposes of 
paragraph (b)(2) of this section, a partner's share of a liability, 
immediately after the partnership assumes or takes subject to the 
liability, is determined by taking into account a subsequent reduction 
in the partner's share if--
    (A) It is anticipated that the partner's share of the liability that 
is allocable to a transfer of money or other consideration to the 
partner will be reduced subsequent to the transfer; and
    (B) The reduction of the partner's share of the liability is part of 
a plan that has as one of its principal purposes minimizing the extent 
to which the partnership's distribution of the proceeds of the borrowing 
is treated as part of a sale.
    (c) Refinancings. To the extent that the proceeds of a partner or 
partnership liability (the refinancing debt) are allocable under the 
rules of Sec. 1.163-8T to payments discharging all or part of any other 
liability of that partner or of the partnership, as the case may be, the 
refinancing debt is treated as the other liability for purposes of 
applying the rules of this section.
    (d) Share of liability where assumption accompanied by transfer of 
money. For purposes of Sec. Sec. 1.707-3 through 1.707-5, if pursuant to 
a plan a partner pays or contributes money to the partnership and the 
partnership assumes or takes subject to one or more liabilities (other 
than qualified liabilities) of the partner, the amount of those 
liabilities that the partnership is treated as assuming or taking 
subject to is reduced (but not below zero) by the money transferred.
    (e) Tiered partnerships and other related persons. If a lower-tier 
partnership succeeds to a liability of an upper-tier partnership, the 
liability in the lower-tier partnership retains the characterization as 
qualified or nonqualified that it had under these rules in the upper-
tier partnership. A similar rule applies to other related party 
transactions involving liabilities to the extent provided by guidance 
published in the Internal Revenue Bulletin.
    (f) Examples. The following examples illustrate the application of 
this section.


[[Page 413]]


    Example 1. Partnership's assumption of nonrecourse liability 
encumbering transferred property. (i) A and B form partnership AB, which 
will engage in renting office space. A transfers $500,000 in cash to the 
partnership, and B transfers an office building to the partnership. At 
the time it is transferred to the partnership, the office building has a 
fair market value of $1,000,000, an adjusted basis of $400,000, and is 
encumbered by a $500,000 liability, which B incurred 12 months earlier 
to finance the acquisition of other property. No facts rebut the 
presumption that the liability was incurred in anticipation of the 
transfer of the property to the partnership. Assume that this liability 
is a nonrecourse liability of the partnership within the meaning of 
section 752 and the regulations thereunder. The partnership agreement 
provides that partnership items will be allocated equally between A and 
B, including excess nonrecourse deductions under Sec. 1.752-3(a)(3). The 
partnership agreement complies with the requirements of Sec. 1.704-
1(b)(2)(ii)(b).
    (ii) The nonrecourse liability secured by the office building is not 
a qualified liability within the meaning of paragraph (a)(6) of this 
section. B would be allocated 50 percent of the excess nonrecourse 
liability under the partnership agreement. Accordingly, immediately 
after the partnership's assumption of that liability, B's share of the 
liability equals $250,000, which is equal to B's 50 percent share of the 
excess nonrecourse liability of the partnership as determined in 
accordance with B's share of partnership profits under Sec. 1.752-
3(a)(3).
    (iii) The partnership's taking subject to the liability encumbering 
the office building is treated as a transfer of $250,000 of 
consideration to B (the amount by which the liability ($500,000) exceeds 
B's share of that liability immediately after taking subject to 
$250,000)). B is treated as having sold $250,000 of the fair market 
value of the office building to the partnership in exchange for the 
partnership's taking subject to a $250,000 liability. This results in a 
gain of $150,000 ($250,000 minus ($250,000/$1,000,000 multiplied by 
$400,000)).
    Example 2. Partnership's assumption of recourse liability 
encumbering transferred property. (i) C transfers property Y to a 
partnership. At the time of its transfer to the partnership, property Y 
has a fair market value of $10,000,000 and is subject to an $8,000,000 
liability that C incurred, immediately before transferring property Y to 
the partnership, in order to finance other expenditures. Upon the 
transfer of property Y to the partnership, the partnership assumed the 
liability encumbering that property. The partnership assumed this 
liability solely to acquire property Y. Under section 752 and the 
regulations thereunder, immediately after the partnership's assumption 
of the liability encumbering property Y, the liability is a recourse 
liability of the partnership and C's share of that liability is 
$7,000,000.
    (ii) Under the facts of this example, the liability encumbering 
property Y is not a qualified liability.
    Accordingly, the partnership's assumption of the liability results 
in a transfer of consideration to C in connection with C's transfer of 
property Y to the partnership in the amount of $1,000,000 (the excess of 
the liability assumed by the partnership ($8,000,000) over C's share of 
the liability immediately after the assumption ($7,000,000)). See 
paragraphs (a) (1) and (2) of this section.
    Example 3. Subsequent reduction of transferring partner's share of 
liability. (i) The facts are the same as in Example 2. In addition, 
property Y is a fully leased office building, the rental income from 
property Y is sufficient to meet debt service, and the remaining term of 
the liability is ten years. It is anticipated that, three years after 
the partnership's assumption of the liability, C's share of the 
liability under section 752 will be reduced to zero because of a shift 
in the allocation of partnership losses pursuant to the terms of the 
partnership agreement. Under the partnership agreement, this shift in 
the allocation of partnership losses is dependent solely on the passage 
of time.
    (ii) Under paragraph (a)(3) of this section, if the reduction in C's 
share of the liability was anticipated at the time of C's transfer, and 
the reduction was part of a plan that has as one of its principal 
purposes minimizing the extent of sale treatment under Sec. 1.707-3 
(i.e., a principal purpose of allocating a large percentage of losses to 
C in the first three years when losses were not likely to be realized 
was to minimize the extent to which C's transfer would be treated as 
part of a sale), C's share of the liability immediately after the 
assumption is treated as equal to C's reduced share.
    Example 4. Trade payables as qualified liabilities. (i) D and E form 
partnership DE which will engage in a consulting business that requires 
no overhead and minimal cash on hand for daily operating expenses. 
Previously, D and E, as individual sole proprietors, operated separate 
consulting businesses. D and E each transfer to the partnership 
sufficient cash to cover daily operating expenses together with the 
goodwill and trade payables related to each sole proprietorship. Due to 
uncertainty over the collection rate on the trade receivables related to 
their sole proprietorships, D and E agree that none of the trade 
receivables will be transferred to the partnership.
    (ii) Under the facts of this example, all the assets related to the 
consulting business (other than the trade receivables) together with the 
trade payables were transferred to partnership DE. The trade receivables 
retained by D and E are not material to a continuation of the trade or 
business by the

[[Page 414]]

partnership because D and E contributed sufficient cash to cover daily 
operating expenses. Accordingly, the trade payables transferred to the 
partnership constitute qualified liability under paragraph (a)(6) of 
this section.
    Example 5. Partnership's assumption of a qualified liability as sole 
consideration. (i) F transfers property Z to a partnership. At the time 
of its transfer to the partnership, property Z has a fair market value 
of $165,000 and an adjusted tax basis of $75,000. Also, at the time of 
the transfer, property Z is subject to a $75,000 liability that F 
incurred more than two years before transferring property Z to the 
partnership. The liability has been secured by property Z since it was 
incurred by F. Upon the transfer of property Z to the partnership, the 
partnership assumed the liability encumbering that property. The 
partnership made no other transfers to F in consideration for the 
transfer of property Z to the partnership. Assume that, under section 
752 and the regulations thereunder, immediately after the partnership's 
assumption of the liability encumbering property Z, the liability is a 
recourse liability of the partnership and F's share of that liability is 
$25,000.
    (ii) The $75,000 liability secured by property Z is a qualified 
liability of F because F incurred the liability more than two years 
prior to the assumption of the liability by the partnership and the 
liability has encumbered property Z for more than two years prior to 
that assumption. See paragraph (a)(6) of this section. Therefore, since 
no other transfer to F was made as consideration for the transfer of 
property Z, under paragraph (a)(5) of this section, the partnership's 
assumption of the qualified liability of F encumbering property Z is not 
treated as part of a sale.
    Example 6. Partnership's assumption of a qualified liability in 
addition to other consideration. (i) The facts are the same as in 
Example 5, except that the partnership makes a transfer to D of $30,000 
in money that is consideration for F's transfer of property Z to the 
partnership under Sec. 1.707-3.
    (ii) As in Example 5, the $75,000 liability secured by property Z is 
a qualified liability of F. Since the partnership transferred $30,000 to 
F in addition to assuming the qualified liability under paragraph (a)(5) 
of this section, the partnership's assumption of this qualified 
liability is treated as a transfer of additional consideration to F to 
the extent of the lesser of--
    (A) The amount that the partnership would be treated as transferring 
to F if the liability were not a qualified liability ($50,000 (i.e., the 
excess of the $75,000 qualified liability over F's $25,000 share of that 
liability)); or
    (B) The amount obtained by multiplying the qualified liability 
($75,000) by F's net equity percentage with respect to property Z (one-
third).
    (iii) F's net equity percentage with respect to property Z equals 
the fraction determined by dividing--
    (A) The aggregate amount of money or other consideration (other than 
the qualified liability) transferred to F and treated as part of a sale 
of property Z under Sec. 1.707-3(a) ($30,000 transfer of money); by
    (B) F's net equity in property Z ($90,000 (i.e., the excess of the 
$165,000 fair market value over the $75,000 qualified liability)).
    (iv) Accordingly, the partnership's assumption of the qualified 
liability of F encumbering property Z is treated as a transfer of 
$25,000 (one-third of $75,000) of consideration to F pursuant to a sale. 
Therefore, F is treated as having sold $55,000 of the fair market value 
of property Z to the partnership in exchange for $30,000 in money and 
the partnership's assumption of $25,000 of the qualified liability. 
Accordingly, F must recognize $30,000 of gain on the sale (the excess of 
the $55,000 amount realized over $25,000 of F's adjusted basis for 
property, Z (i.e., one-third of F's adjusted basis for the property, 
because F is treated as having sold one-third of the property to the 
partnership)).
    Example 7. Partnership's assumptions of liabilities encumbering 
properties transferred pursuant to a plan. (i) Pursuant to a plan, G and 
H transfer property 1 and property 2, respectively, to an existing 
partnership in exchange for interests in the partnership. At the time 
the properties are transferred to the partnership, property 1 has a fair 
market value of $10,000 and an adjusted tax basis of $6,000, and 
property 2 has a fair market value of $10,000 and an adjusted tax basis 
of $4,000. At the time properties 1 and 2 are transferred to the 
partnership, a $6,000 nonrecourse liability (liability 1) is secured by 
property 1 and a $7,000 recourse liability of F (liability 2) is secured 
by property 2. Properties 1 and 2 are transferred to the partnership, 
and the partnership takes subject to liability 1 and assumes liability 
2. G and H incurred liabilities 1 and 2 immediately prior to 
transferring properties 1 and 2 to the partnership and used the proceeds 
for personal expenditures. The liabilities are not qualified 
liabilities. Assume that G and H are each allocated $2,000 of liability 
1 in accordance with Sec. 1.707-5(a)(2)(ii) (which determines a 
partner's share of a nonrecourse liability). Assume further that G's 
share of liability 2 is $3,500 and H's share is $0 in accordance with 
Sec. 1.707-5(a)(2)(i) (which determines a partner's share of a recourse 
liability).
    (ii) G and H transferred properties 1 and 2 to the partnership 
pursuant to a plan. Accordingly, the partnership's taking subject to 
liability 1 is treated as a transfer of only $500 of consideration to G, 
(the amount by which liability 1 ($6,000) exceeds G's share of 
liabilities 1 and 2 ($5,500)), and the partnership's assumption of 
liability 2 is treated as a transfer of only $5,000 of consideration to 
H

[[Page 415]]

(the amount by which liability 2 ($7,000) exceeds H's share of 
liabilities 1 and 2 ($2,000)). G is treated under the rule in 
Sec. 1.707-3 as having sold $500 of the fair market value of property 1 
in exchange for the partnership's taking subject to liability 1 and H is 
treated as having sold $5,000 of the fair market value of property 2 in 
exchange for the assumption of liability 2.
    Example 8. Partnership's assumption of liability pursuant to a plan 
to avoid sale treatment of partnership assumption of another liability. 
(i) The facts are the same as in Example 7, except that--
    (A) H transferred the proceeds of liability 2 to the partnership; 
and
    (B) H incurred liability 2 in an attempt to reduce the extent to 
which the partnership's taking subject to liability 1 would be treated 
as a transfer of consideration to G (and thereby reduce the portion of 
G's transfer of property 1 to the partnership that would be treated as 
part of a sale).
    (ii) Because the partnership assumed liability 2 with a principal 
purpose of reducing the extent to which the partnership's taking subject 
to liability 1 would be treated as a transfer of consideration to G, 
liability 2 is ignored in applying paragraph (a)(3) of this section. 
Accordingly, the partnership's taking subject to liability 1 is treated 
as a transfer of $4,000 of consideration to G (the amount by which 
liability 1 ($6,000) exceeds G's share of liability 1 ($2,000)). On the 
other hand, the partnership's assumption of liability 2 is not treated 
as a transfer of any consideration to H because H's share of that 
liability equals $7,000 as a result of H's transfer of $7,000 in money 
to the partnership.
    Example 9. Partnership's assumptions of qualified liabilities 
encumbering properties transferred pursuant to a plan in addition to 
other consideration. (i) Pursuant to a plan, I transfers property 1 and 
J transfers property 2 plus $10,000 in cash to partnership IJ in 
exchange for equal interests in the partnership. At the time the 
properties are transferred to the partnership, property 1 has a fair 
market value of $100,000, an adjusted tax basis of $5,000, and is 
encumbered by a qualified liability of $50,000 (liability 1). Property 2 
has a fair market value of $100,000, an adjusted tax basis of $5,000, 
and is encumbered by a qualified liability of $70,000 (liability 2). 
Pursuant to the plan, the partnership transferred to I $10,000 in cash. 
That amount is consideration for I's transfer of property 1 to the 
partnership under Sec. 1.707-3. In accordance with Sec. 1.707-5(a)(2), I 
and J are each allocated $25,000 of liability 1 and $35,000 of liability 
2.
    (ii) Because the partnership transferred $10,000 to I as 
consideration for the transfer of property, under Sec. 1.707-5(a)(5), 
the partnership's assumption of liability 1 is treated as a transfer of 
additional consideration to I, even though liability 1 is a qualified 
liability, to the extent of the lesser of--
    (A) The amount that the partnership would be treated as transferring 
to I if the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the qualified liability by 
I's net equity percentage with respect to property 1.
    (iii) Because I and J transferred properties 1 and 2 to the 
partnership pursuant to a plan, treating I's qualified liability as a 
nonqualified liability under Sec. 1.707-5(a)(5)(i)(A) enables I to apply 
the special rule applicable to transfers of encumbered property to a 
partnership by more than one partner pursuant to a plan under 
Sec. 1.707-5(a)(4). Under this alternative test, the partnership's 
assumption of liability 1 encumbering property 1 is treated as a 
transfer of zero ($0) additional consideration to I pursuant to a sale. 
This is because the amount of liability 1 ($50,000) does not exceed the 
sum of I's share of liability 1 treated as a nonqualified liability 
($25,000) and I's share of liability 2 ($35,000)).
    (iv) The alternative under Sec. 1.707-5(a)(5)(i)(B) is the amount 
obtained by multiplying the qualified liability ($50,000) by I's net 
equity percentage with respect to property 1. I's net equity percentage 
with respect to property 1 equals one-fifth, the fraction determined by 
dividing--
    (A) The aggregate amount of money or other consideration (other than 
the qualified liability) transferred to I and treated as part of a sale 
of property 1 under Sec. 1.707-3(a) (the $10,000 transfer of money; by
    (B) I's net equity in property 1 ($50,000 i.e., the excess of the 
$100,000 fair market value over the $50,000 qualified liability).
    (v) Under this alternative test, the partnership's assumption of the 
qualified liability encumbering property 1 is treated as a transfer of 
$10,000 (one-fifth of the $50,000 qualified liability) of additional 
consideration to I pursuant to a sale.
    (vi) Applying Sec. 1.707-5(a)(5) to these facts, the partnership's 
assumption of liability 1 is treated as a transfer of additional 
consideration to I to the extent of the lesser of--
    (A) zero; or
    (B) $10,000.
    (vii) Therefore, the partnership's assumption of I's qualified 
liability encumbering property 1 is not treated as a transfer of any 
additional consideration to I pursuant to a sale, and I is treated as 
having only received $10,000 of the fair market value of property 1 to 
the partnership in exchange for $10,000 in cash. Accordingly, I must 
recognize $9,500 of gain on the sale, that is, the excess of the $10,000 
amount realized over $500 of I's adjusted tax basis for property 1 (one-
tenth of I's adjusted tax basis for the property, because I is treated 
as having sold one-tenth of the property to the partnership). Since no

[[Page 416]]

other transfer to J was made as consideration for the transfer of 
property 2, the partnership's assumption of the qualified liability of J 
encumbering property 2 is not treated as part of a sale.
    Example 10. Treatment of debt-financed transfers of consideration by 
partnership. (i) K transfers property Z to partnership KL in exchange 
for an interest therein on April 9, 1992. On September 13, 1992, the 
partnership incurs a liability of $20,000. On November 17, 1992, the 
partnership transfers $20,000 to K, and $10,000 of this transfer is 
allocable under the rules of Sec. 1.163-8T to proceeds of the 
partnership liability incurred on September 13, 1992. The remaining 
$10,000 is paid from other partnership funds. Assume that, under section 
752 and the corresponding regulations, the $20,000 liability incurred on 
September 13, 1992, is a recourse liability of the partnership and K's 
share of that liability is $10,000 on November 17, 1992.
    (ii) Because a portion of the transfer made to K on November 17, 
1992, is allocable under Sec. 1.163-8T to proceeds of a partnership 
liability that was incurred by the partnership within 90 days of that 
transfer, K is required to take the transfer into account in applying 
the rules of this section and Sec. 1.707-3 only to the extent that the 
amount of the transfer exceeds K's allocable share of the liability used 
to fund the transfer. K's allocable share of the $20,000 liability used 
to fund $10,000 of the transfer to K is $5,000 (K's share of the 
liability ($10,000) multiplied by the fraction obtained by dividing--
    (A) The amount of the liability that is allocable to the 
distribution to K ($10,000); by
    (B) The total amount of such liability ($20,000)).
    (iii) Therefore, K is required to take into account only $15,000 of 
the $20,000 partnership transfer to K for purposes of this section and 
Sec. 1.707-3. Under these facts, assuming the within-two-year 
presumption is not rebutted, this $15,000 transfer will be treated under 
the rule in Sec. 1.707-3 as part of a sale by K of property Z to the 
partnership.
    Example 11. Borrowing against pool of receivables. (i) M generates 
receivables which have an adjusted basis of zero in the ordinary course 
of its business. For M to use receivables as security for a loan, a 
commercial lender requires M to transfer the receivables to a 
partnership in which M has a 90 percent interest. In January, 1992, M 
transfers to the partnership receivables with a face value of $100,000. 
N (who is not related to M) transfers $10,000 cash to the partnership in 
exchange for a 10 percent interest. The partnership borrows $80,000, 
secured by the receivables, and makes a distribution of $72,000 of the 
proceeds to M and $8,000 of the proceeds to N within 90 days of 
incurring the liability. M's share of the liability under Sec. 1.707-
5(a)(2) is $72,000 (90 percent  x  $80,000).
    (ii) Because the transfer of the loan proceeds to M is allocable 
under Sec. 1.163-8T to proceeds of a partnership loan that was incurred 
by the partnership within 90 days of that transfer, M is required to 
take the transfer into account in applying the rules of this section and 
Sec. 1.707-3 only to the extent that the amount of the transfer 
($72,000) exceeds M's allocable share of the liability used to fund the 
transfer. Because the distribution was a debt-financed transfer pursuant 
to a plan, M's allocable share of the liability is $72,000 ($72,000  x  
$80,000/80,000) under Sec. 1.707-5(b)(2)(ii). Therefore, M is not 
required to take into account any of the loan proceeds for purposes of 
this section and Sec. 1.707-3.
    (iii) When the receivables are collected, M must be allocated the 
gain on the contributed receivables under section 704(c). However, the 
lender permits the partnership to distribute cash to the partners only 
to the extent of the value of new receivables contributed to the 
partnership. In 1993, M contributes additional receivables and receives 
a distribution of cash. The taxable income recognized by the partnership 
on the receivables is taxable income of the partnership arising in the 
ordinary course of the partnership's activities. To the extent the 
distribution does not exceed 90 percent (M's percentage interest in 
overall partnership profits) of the partnership's operating cash flow 
under Sec. 1.707-4(b), the distribution to M is presumed not to be a 
part of a sale of receivables by M to the partnership, and the 
presumption is not rebutted under these facts.

[T.D. 8439, 57 FR 44983, Sept. 30, 1992]



Sec. 1.707-6  Disguised sales of property by partnership to partner; general rules.

    (a) In general. Rules similar to those provided in Sec. 1.707-3 
apply in determining whether a transfer of property by a partnership to 
a partner and one or more transfers of money or other consideration by 
that partner to the partnership are treated as a sale of property, in 
whole or in part, to the partner.
    (b) Special rules relating to liabilities--(1) In general. Rules 
similar to those provided in Sec. 1.707-5 apply to determine the extent 
to which an assumption of or taking subject to a liability by a partner, 
in connection with a transfer of property by a partnership, is 
considered part of a sale. Accordingly, if a partner assumes or takes 
property subject to a qualified liability (as defined in paragraph 
(b)(2) of this section) of a partnership, the partner is treated as

[[Page 417]]

transferring consideration to the partnership only to the extent 
provided in paragraph (b). If the partner assumes or takes subject to a 
liability that is not a qualified liability, the amount treated as 
consideration transferred to the partnership is the amount that the 
liability assumed or taken subject to by the partner exceeds the 
partner's share of that liability (determined under the rules of 
Sec. 1.707-5(a)(2)) immediately before the transfer. Similar to the 
rules provided in Sec. 1.707-5(a)(4), if more than one partner assumes 
or takes subject to a liability pursuant to a plan, the amount that is 
treated as a transfer of consideration by each partner is the amount by 
which all of the liabilities (other than qualified liabilities) assumed 
or taken subject to by the partner pursuant to the plan exceed the 
partner's share of all of those liabilities immediately before the 
assumption or taking subject to. This paragraph (b)(1) does not apply to 
any liability assumed or taken subject to by a partner with a principal 
purpose of reducing the extent to which any other liability assumed or 
taken subject to by a partner is treated as a transfer of consideration 
under this paragraph (b).
    (2) Qualified liabilities. (i) If a transfer of property by a 
partnership to a partner is not otherwise treated as part of a sale, the 
partner's assumption of or taking subject to a qualified liability is 
not treated as part of a sale. If a transfer of property by a 
partnership to the partner is treated as part of a sale without regard 
to the partner's assumption of or taking subject to a qualified 
liability, the partner's assumption of or taking subject to that 
liability is treated as a transfer of consideration made pursuant to a 
sale of such property to the partner only to the extent of the lesser 
of--
    (A) The amount of consideration that the partner would be treated as 
transferring to the partnership under paragraph (b) of this section if 
the liability were not a qualified liability; or
    (B) The amount obtained by multiplying the amount of the liability 
at the time of its assumption or taking subject to by the partnership's 
net equity percentage with respect to that property.
    (ii) A partnership's net equity percentage with respect to an item 
of property encumbered by a qualified liability equals the percentage 
determined by dividing--
    (A) The aggregate transfers to the partnership from the partner 
(other than any transfer described in this paragraph (b)(2)) that are 
treated as the proceeds realized from the sale of the transferred 
property to the partner; by
    (B) The excess of the fair market value of the property at the time 
it is transferred to the partner over any qualified liabilities of the 
partnership that are assumed or taken subject to by the partner at that 
time.
    (iii) For purposes of this section, the definition of a qualified 
liability is that provided in Sec. 1.707-5(a)(6) with the following 
exceptions--
    (A) In applying the definition, the qualified liability is one that 
is originally an obligation of the partnership and is assumed or taken 
subject to by the partner in connection with a transfer of property to 
the partner; and
    (B) If the liability was incurred by the partnership more than two 
years prior to the earlier of the date the partnership agrees in writing 
to transfer the property or the date the partnership transfers the 
property to the partner, that liability is a qualified liability whether 
or not it has encumbered the transferred property throughout the two-
year period.
    (c) Disclosure rules. Similar to the rules provided in Secs. 1.707-
3(c)(2) and 1.707-5(a)(7)(ii), a partnership is to disclose to the 
Internal Revenue Service, in accordance with Sec. 1.707-8, the facts in 
the following circumstances:
    (1) When a partnership transfers property to a partner and the 
partner transfers money or other consideration to the partnership within 
a two-year period (without regard to the order of the transfers) and the 
partnership treats the transfers as other than a sale for tax purposes; 
and
    (2) When a partner assumes or takes subject to a liability of a 
partnership in connection with a transfer of property by the partnership 
to the partner, and the partnership incurred the liability within the 
two-year period prior to the earlier of the date the partnership

[[Page 418]]

agrees in writing to the transfer of property or the date the 
partnership transfers the property, and the partnership treats the 
liability as a qualified liability under rules similar to Sec. 1.707-
5(a)(6)(i)(B).
    (d) Examples. The following examples illustrate the rules of this 
section.

    Example 1. Sale of property by partnership to partner. (i) A is a 
member of a partnership. The partnership transfers property X to A. At 
the time of the transfer, property X has a fair market value of 
$1,000,000. One year after the transfer, A transfers $1,100,000 to the 
partnership. Assume that under the rules of section 1274 the imputed 
principal amount of an obligation to transfer $1,100,000 one year after 
the transfer of property X is $1,000,000 on the date of the transfer.
    (ii) Since the transfer of $1,100,000 to the partnership by A is 
made within two years of the transfer of property X to A, under rules 
similar to those provided in Sec. 1.707-3(c), the transfers are presumed 
to be a sale unless the facts and circumstances clearly establish 
otherwise. If no facts exist that would rebut this presumption, on the 
date that the partnership transfers property X to A, the partnership is 
treated as having sold property X to A in exchange for A's obligation to 
transfer $1,100,000 to the partnership one year later.
    Example 2. Assumption of liability by partner. (i) B is a member of 
an existing partnership. The partnership transfers property Y to B. On 
the date of the transfer, property Y has a fair market value of 
$1,000,000 and is encumbered by a nonrecourse liability of $600,000. B 
takes the property subject to the liability. The partnership incurred 
the nonrecourse liability six months prior to the transfer of property Y 
to B and used the proceeds to purchase an unrelated asset. Assume that, 
under rule of Sec. 1.707-5(a)(2)(ii) (which determines a partner's share 
of a nonrecourse liability), B's share of the nonrecourse liability 
immediately before the transfer of property Y was $100,000.
    (ii) The liability is not allocable under the rules of Sec. 1.163-8T 
to capital expenditures with respect to the property transferred to B 
and was not incurred in the ordinary course of the trade or business in 
which the property transferred to the partner was used or held. Since 
the partnership incurred the nonrecourse liability within two years of 
the transfer to B, under rules similar to those provided in Sec. 1.707-
5(a)(5), the liability is presumed to be incurred in anticipation of the 
transfer unless the facts and circumstances clearly establish the 
contrary. Assuming no facts exist to rebut this presumption, the 
liability taken subject to by B is not a qualified liability. The 
partnership is treated as having received, on the date of the transfer 
of property Y to B, $500,000 ($600,000 liability assumed by B less B's 
share of the $100,000 liability immediately prior to the transfer) as 
consideration for the sale of one-half ($500,000/$1,000,000) of property 
Y to B. The partnership is also treated as having distributed to B, in 
B's capacity as a partner, the other one-half of property Y.

[T.D. 8439, 57 FR 44987, Sept. 30, 1992]
Sec. 1.707-7  Disguised sales of partnership interests. [Reserved]



Sec. 1.707-8  Disclosure of certain information.

    (a) In general. The disclosure referred to in Sec. 1.707-3(c)(2) 
(regarding certain transfers made within two years of each other), 
Sec. 1.707-5(a)(7)(ii) (regarding a liability incurred within two years 
prior to a transfer of property), and Sec. 1.707-6(c) (relating to 
transfers of property from a partnership to a partner in situations 
analogous to those listed above) is to be made in accordance with 
paragraph (b) of this section.
    (b) Method of providing disclosure. Disclosure is to be made on a 
completed Form 8275 or on a statement attached to the return of the 
transferor of property for the taxable year of the transfer that 
includes the following:
    (1) A caption identifying the statement as disclosure under section 
707;
    (2) An identification of the item (or group of items) with respect 
to which disclosure is made;
    (3) The amount of each item; and
    (4) The facts affecting the potential tax treatment of the item (or 
items) under section 707.
    (c) Disclosure by certain partnerships. If more than one partner 
transfers property to a partnership pursuant to a plan, the disclosure 
required by this section may be made by the partnership on behalf of all 
the transferors rather than by each transferor separately.

[T.D. 8439, 57 FR 44988, Sept. 30, 1992]



Sec. 1.707-9  Effective dates and transitional rules.

    (a) Sections 1.707-3 through 1.707-6--(1) In general. Except as 
provided in paragraph (a)(3) of this section, Secs. 1.707-3 through 
1.707-6 apply to any transaction with respect to which all transfers 
that are part of a sale of an item of property occur after April 24, 
1991.

[[Page 419]]

    (2) Transfers occurring on or before April 24, 1991. Except as 
otherwise provided in paragraph (a)(3) of this section, in the case of 
any transaction with respect to which one or more of the transfers 
occurs on or before April 24, 1991, the determination of whether the 
transaction is a disguised sale of property (including a partnership 
interest) under section 707(a)(2) is to be made on the basis of the 
statute and the guidance provided regarding that provision in the 
legislative history of section 73 of the Tax Reform Act of 1984 (Pub. L. 
98-369, 98 Stat. 494). See H.R. Rep. No. 861, 98th Cong., 2d Sess. 859-
62 (1984); S. Prt. No. 169 (Vol. I), 98th Cong., 2d Sess. 223-32 (1984); 
H.R. Rep. No. 432 (Pt. 2), 98th Cong., 2d Sess. 1216-21 (1984).
    (3) Effective date of section 73 of the Tax Reform Act of 1984. 
Sections 1.707-3 through 1.707-6 do not apply to any transfer of money 
or other consideration to which section 73(a) of the Tax Reform Act of 
1984 (Pub. L. 98-369, 98 Stat. 494) does not apply pursuant to section 
73(b) of that Act.
    (b) Section 1.707-8 disclosure of certain information. The 
disclosure provisions described in Sec. 1.707-8 apply to transactions 
with respect to which all transfers that are part of a sale of property 
occur after September 30, 1992.

[T.D. 8439, 57 FR 44989, Sept. 30, 1992]



Sec. 1.708-1   Continuation of partnership.

    (a) General rule. For purposes of subchapter K, chapter 1 of the 
Code, an existing partnership shall be considered as continuing if it is 
not terminated.
    (b) Termination--(1) General rule. (i) A partnership shall terminate 
when the operations of the partnership are discontinued and no part of 
any business, financial operation, or venture of the partnership 
continues to be carried on by any of its partners in a partnership. For 
example, on November 20, 1956, A and B, each of whom is a 20-percent 
partner in partnership ABC, sell their interests to C, who is a 60-
percent partner. Since the business is no longer carried on by any of 
its partners in a partnership, the ABC partnership is terminated as of 
November 20, 1956. However, where partners DEF agree on April 30, 1957, 
to dissolve their partnership, but carry on the business through a 
winding up period ending September 30, 1957, when all remaining assets, 
consisting only of cash, are distributed to the partners, the 
partnership does not terminate because of cessation of business until 
September 30, 1957.
    (a) Upon the death of one partner in a 2-member partnership, the 
partnership shall not be considered as terminated if the estate or other 
successor in interest of the deceased partner continues to share in the 
profits or losses of the partnership business.
    (b) For the continuation of a partnership where payments are being 
made under section 736 (relating to payments to a retiring partner or a 
deceased partner's successor in interest), see paragraph (a)(6) of 
Sec. 1.736-1.
    (ii) A partnership shall terminate when 50 percent or more of the 
total interest in partnership capital and profits is sold or exchanged 
within a period of 12 consecutive months. Such sale or exchange includes 
a sale or exchange to another member of the partnership. However, a 
disposition of a partnership interest by gift (including assignment to a 
successor in interest), bequest, or inheritance, or the liquidation of a 
partnership interest, is not a sale or exchange for purposes of this 
subparagraph. Furthermore, the contribution of property to a partnership 
does not constitute such a sale or exchange. See, however, paragraph 
(c)(3) of Sec. 1.731-1. Fifty percent or more of the total interest in 
partnership capital and profits means 50 percent or more of the total 
interest in partnership capital plus 50 percent or more of the total 
interest in partnership profits. Thus, the sale of a 30-percent interest 
in partnership capital and a 60-percent interest in partnership profits 
is not the sale or exchange of 50 percent or more of the total interest 
in partnership capital and profits. If one or more partners sell or 
exchange interests aggregating 50 percent or more of the total interest 
in partnership capital and 50 percent or more of the total interest in 
partnership profits within a period of 12 consecutive months, such sale 
or exchange is considered as being within the provisions of this 
subparagraph. When interests are sold or exchanged on different dates, 
the percentages to be added are determined as of the date of each sale.

[[Page 420]]

For example, with respect to the ABC partnership, the sale by A on May 
12, 1956, of a 30-percent interest in capital and profits to D, and the 
sale by B on March 27, 1957, of a 30-percent interest in capital and 
profits to E, is a sale of a 50-percent or more interest. Accordingly, 
the partnership is terminated as of March 27, 1957. However, if, on 
March 27, 1957, D instead of B, sold his 30-percent interest in capital 
and profits to E, there would be no termination since only one 30-
percent interest would have been sold or exchanged within a 12-month 
period.
    (iii) For purposes of subchapter K, chapter 1 of the Code, a 
partnership taxable year closes with respect to all partners on the date 
on which the partnership terminates. See section 706(c)(1) and paragraph 
(c)(1) of Sec. 1.706-1. The date of termination is:
    (a) For purposes of section 708(b)(1)(A), the date on which the 
winding up of the partnership affairs is completed.
    (b) For purposes of section 708(b)(1)(B), the date of the sale or 
exchange of a partnership interest which, of itself or together with 
sales or exchanges in the preceding 12 months, transfers an interest of 
50 percent or more in both partnership capital and profits.
    (iv) If a partnership is terminated by a sale or exchange of an 
interest, the following is deemed to occur: The partnership distributes 
its properties to the purchaser and the other remaining partners in 
proportion to their respective interests in the partnership properties; 
and, immediately thereafter, the purchaser and the other remaining 
partners contribute the properties to a new partnership, either for the 
continuation of the business or for its dissolution and winding up. In 
the latter case, the new partnership terminates in accordance with 
subdivision (i) of this subparagraph. See sections 731 and 732 and 
Secs. 1.731-1 and 1.732-1. For election of basis adjustments by the 
purchaser and other remaining partners, see sections 732(d) and 743(b) 
and paragraph (d) of Sec. 1.732-1 and paragraph (b) of Sec. 1.743-1.
    (2) Special rules--(i) Merger or consolidation. If two or more 
partnerships merge or consolidate into one partnership, the resulting 
partnership shall be considered a continuation of the merging or 
consolidating partnership the members of which own an interest of more 
than 50 percent in the capital and profits of the resulting partnership. 
If the resulting partnership can, under the preceding sentence, be 
considered a continuation of more than one of the merging or 
consolidating partnerships, it shall, unless the Commissioner permits 
otherwise, be considered the continuation of that partnership which is 
credited with the contribution of the greatest dollar value of assets to 
the resulting partnership. Any other merging or consolidating 
partnerships shall be considered as terminated. If the members of none 
of the merging or consolidating partnerships have an interest of more 
than 50 percent in the capital and profits of the resulting partnership, 
all of the merged or consolidated partnerships are terminated, and a new 
partnership results. The taxable years of such merging or consolidating 
partnerships which are considered terminated shall be closed in 
accordance with the provisions of section 706(c), and such partnerships 
shall file their returns for a taxable year ending upon the date of 
termination, i.e., the date of merger or consolidation. The resulting 
partnership shall file a return for the taxable year of the merging or 
consolidating partnership that is considered as continuing. The return 
shall state that the resulting partnership is a continuation of such 
merging or consolidating partnership and shall include the names and 
addresses of the merged or consolidated partnerships. The respective 
distributive shares of the partners for the periods prior to and 
subsequent to the date of merger or consolidation shall be shown as a 
part of the return. The provisions of this subdivision may be 
illustrated by the following example:

    Example. Partnership AB, in whose capital and profits A and B each 
own a 50-percent interest, and partnership CD, in whose capital and 
profits C and D each own a 50-percent interest, merge on September 30, 
1955, and form partnership ABCD. Partners A, B, C, and D are on a 
calendar year; partnership AB is also on a calendar year; and 
partnership CD is on a fiscal year ending June 30th. After the merger, 
the partners have capital and profits interests as follows: A, 30 
percent; B,

[[Page 421]]

30 percent; C, 20 percent; and D, 20 percent. Since A and B together own 
an interest of more than 50 percent in the capital and profits of 
partnership ABCD, such partnership shall be considered a continuation of 
partnership AB and shall continue to file returns on a calendar year 
basis. Since C and D own an interest of less than 50 percent in the 
capital and profits of partnership ABCD, the taxable year of partnership 
CD closes as of September 30, 1955, the date of the merger, and CD 
partnership is terminated as of that date. Partnership ABCD is required 
to file a return for the taxable year January 1 to December 31, 1955, 
indicating thereon that, until September 30, 1955, it was partnership 
AB. Partnership CD is required to file a return for its final taxable 
year, July 1 through September 30, 1955.

    (ii) Division of a partnership. Upon the division of a partnership 
into two or more partnerships, any resulting partnership or partnerships 
shall be considered a continuation of the prior partnership if its 
members had an interest of more than 50 percent in the capital and 
profits of the prior partnership. Any other resulting partnership will 
not be considered a continuation of the prior partnership but will be 
considered a new partnership. If the members of none of the resulting 
partnerships owned an interest of more than 50 percent in the capital 
and profits of the divided partnership, the divided partnership is 
terminated. Where members of a partnership which has been divided into 
two or more partnerships do not become members of a resulting 
partnership which is considered a continuation of the prior partnership, 
such partner's interests shall be considered liquidated as of the date 
of the division. The resulting partnership that is regarded as 
continuing shall file a return for the taxable year of the partnership 
that has been divided. The return shall state that the partnership is a 
continuation of the divided partnership and shall set forth separately 
the respective distributive shares of the partners for the periods prior 
to and subsequent to the date of division. The provisions of this 
subdivision may be illustrated by the following example:

    Example. Partnership ABCD is in the real estate and insurance 
business. A owns a 40-percent interest, and B, C, and D each owns a 20-
percent interest, in the capital and profits of the partnership. The 
partnership and the partners report their income on a calendar year. 
They agree to separate the real estate and insurance business as of 
November 1, 1955, and to form two partnerships; partnership AB to take 
over the real estate business, and partnership CD to take over the 
insurance business. Since members of resulting partnership AB owned more 
than a 50-percent interest in the capital and profits of partnership 
ABCD (A, 40 percent, and B, 20 percent), partnership AB shall be 
considered a continuation of partnership ABCD. Partnership AB is 
required to file a return for the taxable year January 1 to December 31, 
1955, indicating thereon that until November 1, 1955, it was partnership 
ABCD. In forming partnership CD, partners C and D may contribute the 
property distributed to them in liquidation of their entire interests in 
divided partnership ABCD. Partnership CD will be required to file a 
return for the taxable year it adopts pursuant to section 706(b) and 
paragraph (b) of Sec. 1.706-1.



Sec. 1.709-1  Treatment of organization and syndication costs.

    (a) General rule. Except as provided in paragraph (b) of this 
section, no deduction shall be allowed under chapter 1 of the Code to a 
partnership or to any partner for any amounts paid or incurred, directly 
or indirectly, in partnership taxable years beginning after December 31, 
1975, to organize a partnership, or to promote the sale of, or to sell, 
an interest in the partnership.
    (b) Amortization of organization expenses. (1) Under section 709(b) 
of the Code, a partnership may elect to treat its organizational 
expenses (as defined in section 709(b)(2) and in Sec. 1.709-2(a)) paid 
or incurred in partnership taxable years beginning after December 31, 
1976, as deferred expenses. If a partnership elects to amortize 
organizational expenses, it must select a period of not less than 60 
months, over which the partnership will amortize all such expenses on a 
straight line basis. This period must begin with the month in which the 
partnership begins business (as determined under Sec. 1.709-2(c)). 
However, in the case of a partnership on the cash receipts and 
disbursements method of accounting, no deduction shall be allowed for a 
taxable year with respect to any such expenses that have not been paid 
by the end of that taxable year. Portions of such expenses which would 
have been deductible under section 709(b) in a prior taxable year if the 
expenses had been paid are deductible in the year of payment. The

[[Page 422]]

election is irrevocable and the period selected by the partnership in 
making its election may not be subsequently changed.
    (2) If there is a winding up and complete liquidation of the 
partnership prior to the end of the amortization period, the unamortized 
amount of organizational expenses is a partnership deduction in its 
final taxable year to the extent provided under section 165 (relating to 
losses). However, there is no partnership deduction with respect to its 
capitalized syndication expenses.
    (c) Time and manner of making election. The election to amortize 
organizational expenses provided by section 709(b) shall be made by 
attaching a statement to the partnership's return of income for the 
taxable year in which the partnership begins business. The statement 
shall set forth a description of each organizational expense incurred 
(whether or not paid) with the amount of the expense, the date each 
expense was incurred, the month in which the partnership began business, 
and the number of months (not less than 60) over which the expenses are 
to be amortized. A taxpayer on the cash receipts and disbursements 
method of accounting shall also indicate the amount paid before the end 
of the taxable year with respect to each such expense. Expenses less 
than $10 need not be separately listed, provided the total amount of 
these expenses is listed with the dates on which the first and last of 
such expenses were incurred, and, in the case of a taxpayer on the cash 
receipts and disbursements method of accounting, the aggregate amount of 
such expenses that was paid by the end of the taxable year is stated. In 
the case of a partnership which begins business in a taxable year that 
ends after March 31, 1983, the original return and statement must be 
filed (and the election made) not later than the date prescribed by law 
for filing the return (including any extensions of time) for that 
taxable year. Once an election has been made, an amended return (or 
returns) and statement (or statements) may be filed to include any 
organizational expenses not included in the partnership's original 
return and statement.

[T.D. 7891, 48 FR 20048, May 4, 1983]



Sec. 1.709-2  Definitions.

    (a) Organizational expenses. Section 709(b)(2) of the Internal 
Revenue Code defines organizational expenses as expenses which:
    (1) Are incident to the creation of the partnership;
    (2) Are chargeable to capital account; and
    (3) Are of a character which, if expended incident to the creation 
of a partnership having an ascertainable life, would (but for section 
709(a)) be amortized over such life.

An expenditure which fails to meet one or more of these three tests does 
not qualify as an organizational expense for purposes of section 709(b) 
and this section. To satisfy the statutory requirement described in 
paragraph (a)(1) of this section, the expense must be incurred during 
the period beginning at a point which is a reasonable time before the 
partnership begins business and ending with the date prescribed by law 
for filing the partnership return (determined without regard to any 
extensions of time) for the taxable year the partnership begins 
business. In addition, the expenses must be for creation of the 
partnership and not for operation or starting operation of the 
partnership trade or business. To satisfy the statutory requirement 
described in paragraph (a)(3) of this section, the expense must be for 
an item of a nature normally expected to benefit the partnership 
throughout the entire life of the partnership. The following are 
examples of organizational expenses within the meaning of section 709 
and this section: Legal fees for services incident to the organization 
of the partnership, such as negotiation and preparation of a partnership 
agreement; accounting fees for services incident to the organization of 
the partnership; and filing fees. The following are examples of expenses 
that are not organizational expenses within the meaning of section 709 
and this section (regardless of how the partnership characterizes them): 
Expenses connected with acquiring assets for the partnership or 
transferring assets to the partnership; expenses connected with the 
admission or removal of partners other than at

[[Page 423]]

the time the partnership is first organized; expenses connected with a 
contract relating to the operation of the partnership trade or business 
(even where the contract is between the partnership and one of its 
members); and syndication expenses.
    (b) Syndication expenses. Syndication expenses are expenses 
connected with the issuing and marketing of interests in the 
partnership. Examples of syndication expenses are brokerage fees; 
registration fees; legal fees of the underwriter or placement agent and 
the issuer (the general partner or the partnership) for securities 
advice and for advice pertaining to the adequacy of tax disclosures in 
the prospectus or placement memorandum for securities law purposes; 
accounting fees for preparation of representations to be included in the 
offering materials; and printing costs of the prospectus, placement 
memorandum, and other selling and promotional material. These expenses 
are not subject to the election under section 709(b) and must be 
capitalized.
    (c) Beginning business. The determination of the date a partnership 
begins business for purposes of section 709 presents a question of fact 
that must be determined in each case in light of all the circumstances 
of the particular case. Ordinarily, a partnership begins business when 
it starts the business operations for which it was organized. The mere 
signing of a partnership agreement is not alone sufficient to show the 
beginning of business.

If the activities of the partnership have advanced to the extent 
necessary to establish the nature of its business operations, it will be 
deemed to have begun business. Accordingly, the acquisition of operating 
assets which are necessary to the type of business contemplated may 
constitute beginning business for these purposes. The term operating 
assets, as used herein, means assets that are in a state of readiness to 
be placed in service within a reasonable period following their 
acquisition.

[T.D. 7891, 48 FR 20049, May 4, 1983]

               Contributions, Distributions, and Transfers

                      contributions to a partnership



Sec. 1.721-1   Nonrecognition of gain or loss on contribution.

    (a) No gain or loss shall be recognized either to the partnership or 
to any of its partners upon a contribution of property, including 
installment obligations, to the partnership in exchange for a 
partnership interest. This rule applies whether the contribution is made 
to a partnership in the process of formation or to a partnership which 
is already formed and operating. Section 721 shall not apply to a 
transaction between a partnership and a partner not acting in his 
capacity as a partner since such a transaction is governed by section 
707. Rather than contributing property to a partnership, a partner may 
sell property to the partnership or may retain the ownership of property 
and allow the partnership to use it. In all cases, the substance of the 
transaction will govern, rather than its form. See paragraph (c)(3) of 
Sec. 1.731-1. Thus, if the transfer of property by the partner to the 
partnership results in the receipt by the partner of money or other 
consideration, including a promissory obligation fixed in amount and 
time for payment, the transaction will be treated as a sale or exchange 
under section 707 rather than as a contribution under section 721. For 
the rules governing the treatment of liabilities to which contributed 
property is subject, see section 752 and Sec. 1.752-1.
    (b)(1) Normally, under local law, each partner is entitled to be 
repaid his contributions of money or other property to the partnership 
(at the value placed upon such property by the partnership at the time 
of the contribution) whether made at the formation of the partnership or 
subsequent thereto. To the extent that any of the partners gives up any 
part of his right to be repaid his contributions (as distinguished from 
a share in partnership profits) in favor of another partner as 
compensation for services (or in satisfaction of an obligation), section 
721 does not apply. The value of an interest in such partnership

[[Page 424]]

capital so transferred to a partner as compensation for services 
constitutes income to the partner under section 61. The amount of such 
income is the fair market value of the interest in capital so 
transferred, either at the time the transfer is made for past services, 
or at the time the services have been rendered where the transfer is 
conditioned on the completion of the transferee's future services. The 
time when such income is realized depends on all the facts and 
circumstances, including any substantial restrictions or conditions on 
the compensated partner's right to withdraw or otherwise dispose of such 
interest. To the extent that an interest in capital representing 
compensation for services rendered by the decedent prior to his death is 
transferred after his death to the decedent's successor in interest, the 
fair market value of such interest is income in respect of a decedent 
under section 691.
    (2) To the extent that the value of such interest is: (i) 
Compensation for services rendered to the partnership, it is a 
guaranteed payment for services under section 707(c); (ii) compensation 
for services rendered to a partner, it is not deductible by the 
partnership, but is deductible only by such partner to the extent 
allowable under this chapter.
    (c) Underwritings of partnership interests--(1) In general. For the 
purpose of section 721, if a person acquires a partnership interest from 
an underwriter in exchange for cash in a qualified underwriting 
transaction, the person who acquires the partnership interest is treated 
as transferring cash directly to the partnership in exchange for the 
partnership interest and the underwriter is disregarded. A qualified 
underwriting transaction is a transaction in which a partnership issues 
partnership interests for cash in an underwriting in which either the 
underwriter is an agent of the partnership or the underwriter's 
ownership of the partnership interests is transitory.
    (2) Effective date. This paragraph (c) is effective for qualified 
underwriting transactions occurring on or after May 1, 1996.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 8665, 61 FR 19189, May 1, 1996]



Sec. 1.722-1   Basis of contributing partner's interest.

    The basis to a partner of a partnership interest acquired by a 
contribution of property, including money, to the partnership shall be 
the amount of money contributed plus the adjusted basis at the time of 
contribution of any property contributed. If the acquisition of an 
interest in partnership capital results in taxable income to a partner, 
such income shall constitute an addition to the basis of the partner's 
interest. See paragraph (b) of Sec. 1.721-1. If the contributed property 
is subject to indebtedness or if liabilities of the partner are assumed 
by the partnership, the basis of the contributing partner's interest 
shall be reduced by the portion of the indebtedness assumed by the other 
partners, since the partnership's assumption of his indebtedness is 
treated as a distribution of money to the partner. Conversely, the 
assumption by the other partners of a portion of the contributor's 
indebtedness is treated as a contribution of money by them. See section 
752 and Sec. 1.752-1. The provisions of this section may be illustrated 
by the following examples:

    Example 1. A acquired a 20-percent interest in a partnership by 
contributing property. At the time of A's contribution, the property had 
a fair market value of $10,000, an adjusted basis to A of $4,000, and 
was subject to a mortgage of $2,000. Payment of the mortgage was assumed 
by the partnership. The basis of A's interest in the partnership is 
$2,400, computed as follows:

Adjusted basis to A of property contributed.................      $4,000
Less portion of mortgage assumed by other partners which                
 must be treated as a distribution (80 percent of $2,000)...       1,600
                                                             -----------
    Basis of A's interest...................................       2,400
                                                                        

    Example 2. If, in example 1 of this section, the property 
contributed by A was subject to a mortgage of $6,000, the basis of A's 
interest would be zero, computed as follows:

Adjusted basis to A of property contributed.................      $4,000
Less portion of mortgage assumed by other partners which                
 must be treated as a distribution (80 percent of $6,000)...       4,800
                                                             -----------
                                                                   (800)
                                                                        

Since A's basis cannot be less than zero, the $800 in excess of basis, 
which is considered as a distribution of money under section 752(b), is 
treated as capital gain from the sale or exchange or a partnership 
interest. See section 731(a).

[[Page 425]]



Sec. 1.723-1   Basis of property contributed to partnership.

    The basis to the partnership of property contributed to it by a 
partner is the adjusted basis of such property to the contributing 
partner at the time of the contribution. Since such property has the 
same basis in the hands of the partnership as it had in the hands of the 
contributing partner, the holding period of such property for the 
partnership includes the period during which it was held by the partner. 
See section 1223(2). For elective adjustments to the basis of 
partnership property arising from distributions or transfers of 
partnership interests, see sections 732(d), 734(b), and 743(b).

                     distributions by a partnership



Sec. 1.731-1   Extent of recognition of gain or loss on distribution.

    (a) Recognition of gain or loss to partner--(1) Recognition of gain. 
(i) Where money is distributed by a partnership to a partner, no gain 
shall be recognized to the partner except to the extent that the amount 
of money distributed exceeds the adjusted basis of the partner's 
interest in the partnership immediately before the distribution. This 
rule is applicable both to current distributions (i.e., distributions 
other than in liquidation of an entire interest) and to distributions in 
liquidation of a partner's entire interest in a partnership. Thus, if a 
partner with a basis for his interest of $10,000 receives a distribution 
of cash of $8,000 and property with a fair market value of $3,000, no 
gain is recognized to him. If $11,000 cash were distributed, gain would 
be recognized to the extent of $1,000. No gain shall be recognized to a 
distributee partner with respect to a distribution of property (other 
than money) until he sells or otherwise disposes of such property, 
except to the extent otherwise provided by section 736 (relating to 
payments to a retiring partner or a deceased partner's successor in 
interest) and section 751 (relating to unrealized receivables and 
inventory items). See section 731(c) and paragraph (c) of this section.
    (ii) For the purposes of sections 731 and 705, advances or drawings 
of money or property against a partner's distributive share of income 
shall be treated as current distributions made on the last day of the 
partnership taxable year with respect to such partner.
    (2) Recognition of loss. Loss is recognized to a partner only upon 
liquidation of his entire interest in the partnership, and only if the 
property distributed to him consists solely of money, unrealized 
receivables (as defined in section 751(c)), and inventory items (as 
defined in section 751(d)(2)). The term liquidation of a partner's 
interest, as defined in section 761(d), is the termination of the 
partner's entire interest in the partnership by means of a distribution 
or a series of distributions. Loss is recognized to the distributee 
partner in such cases to the extent of the excess of the adjusted basis 
of such partner's interest in the partnership at the time of the 
distribution over the sum of:
    (i) Any money distributed to him, and
    (ii) The basis to the distributee, as determined under section 732, 
of any unrealized receivables and inventory items that are distributed 
to him.

If the partner whose interest is liquidated receives any property other 
than money, unrealized receivables, or inventory items, then no loss 
will be recognized. Application of the provisions of this subparagraph 
may be illustrated by the following examples:

    Example 1. Partner A has a partnership interest in partnership ABC 
with an adjusted basis to him of $10,000. He retires from the 
partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $5,000 cash 
and inventory with a basis to him (under section 732) of $3,000. Partner 
A realizes a capital loss of $2,000, which is recognized under section 
731(a)(2).
    Example 2. Partner B has a partnership interest in partnership BCD 
with an adjusted basis to him of $10,000. He retires from the 
partnership and receives, as a distribution in liquidation of his entire 
interest, his share of partnership property. This share is $4,000 cash, 
real property (used in the trade or business) with an adjusted basis to 
the partnership of $2,000, and unrealized receivables having a basis to 
him (under section 732) of $3,000. No loss will be recognized to B on 
the transaction because he received property other than money, 
unrealized receivables, and inventory items. As determined under

[[Page 426]]

section 732, the basis to B for the real property received is $3,000.

    (3) Character of gain or loss. Gain or loss recognized under section 
731(a) on a distribution is considered gain or loss from the sale or 
exchange of the partnership interest of the distributee partner, that 
is, capital gain or loss.
    (b) Gain or loss recognized by partnership. A distribution of 
property (including money) by a partnership to a partner does not result 
in recognized gain or loss to the partnership under section 731. 
However, recognized gain or loss may result to the partnership from 
certain distributions which, under section 751(b), must be treated as a 
sale or exchange of property between the distributee partner and the 
partnership.
    (c) Exceptions. (1) Section 731 does not apply to the extent 
otherwise provided by:
    (i) Section 736 (relating to payments to a retiring partner or to a 
deceased partner's successor in interest) and
    (ii) Section 751 (relating to unrealized receivables and inventory 
items).

For example, payments under section 736(a), which are considered as a 
distributive share or guaranteed payment, are taxable as such under that 
section.
    (2) The receipt by a partner from the partnership of money or 
property under an obligation to repay the amount of such money or to 
return such property does not constitute a distribution subject to 
section 731 but is a loan governed by section 707(a). To the extent that 
such an obligation is canceled, the obligor partner will be considered 
to have received a distribution of money or property at the time of 
cancellation.
    (3) If there is a contribution of property to a partnership and 
within a short period:
    (i) Before or after such contribution other property is distributed 
to the contributing partner and the contributed property is retained by 
the partnership, or
    (ii) After such contribution the contributed property is distributed 
to another partner,

such distribution may not fall within the scope of section 731. Section 
731 does not apply to a distribution of property, if, in fact, the 
distribution was made in order to effect an exchange of property between 
two or more of the partners or between the partnership and a partner. 
Such a transaction shall be treated as an exchange of property.



Sec. 1.731-2  Partnership distributions of marketable securities.

    (a) Marketable securities treated as money. Except as otherwise 
provided in section 731(c) and this section, for purposes of sections 
731(a)(1) and 737, the term money includes marketable securities and 
such securities are taken into account at their fair market value as of 
the date of the distribution.
    (b) Reduction of amount treated as money--(1) Aggregation of 
securities. For purposes of section 731(c)(3)(B) and this paragraph (b), 
all marketable securities held by a partnership are treated as 
marketable securities of the same class and issuer as the distributed 
security.
    (2) Amount of reduction. The amount of the distribution of 
marketable securities that is treated as a distribution of money under 
section 731(c) and paragraph (a) of this section is reduced (but not 
below zero) by the excess, if any, of--
    (i) The distributee partner's distributive share of the net gain, if 
any, which would be recognized if all the marketable securities held by 
the partnership were sold (immediately before the transaction to which 
the distribution relates) by the partnership for fair market value; over
    (ii) The distributee partner's distributive share of the net gain, 
if any, which is attributable to the marketable securities held by the 
partnership immediately after the transaction, determined by using the 
same fair market value as used under paragraph (b)(2)(i) of this 
section.
    (3) Distributee partner's share of net gain. For purposes of section 
731(c)(3)(B) and paragraph (b)(2) of this section, a partner's 
distributive share of net gain is determined--
    (i) By taking into account any basis adjustments under section 
743(b) with respect to that partner;

[[Page 427]]

    (ii) Without taking into account any special allocations adopted 
with a principal purpose of avoiding the effect of section 731(c) and 
this section; and
    (iii) Without taking into account any gain or loss attributable to a 
distributed security to which paragraph (d)(1) of this section applies.
    (c) Marketable securities--(1) In general. For purposes of section 
731(c) and this section, the term marketable securities is defined in 
section 731(c)(2).
    (2) Actively traded. For purposes of section 731(c) and this 
section, a financial instrument is actively traded (and thus is a 
marketable security) if it is of a type that is, as of the date of 
distribution, actively traded within the meaning of section 1092(d)(1). 
Thus, for example, if XYZ common stock is listed on a national 
securities exchange, particular shares of XYZ common stock that are 
distributed by a partnership are marketable securities even if those 
particular shares cannot be resold by the distributee partner for a 
designated period of time.
    (3) Interests in an entity--(i) Substantially all. For purposes of 
section 731(c)(2)(B)(v) and this section, substantially all of the 
assets of an entity consist (directly or indirectly) of marketable 
securities, money, or both only if 90 percent or more of the assets of 
the entity (by value) at the time of the distribution of an interest in 
the entity consist (directly or indirectly) of marketable securities, 
money, or both.
    (ii) Less than substantially all. For purposes of section 
731(c)(2)(B)(vi) and this section, an interest in an entity is a 
marketable security to the extent that the value of the interest is 
attributable (directly or indirectly) to marketable securities, money, 
or both, if less than 90 percent but 20 percent or more of the assets of 
the entity (by value) at the time of the distribution of an interest in 
the entity consist (directly or indirectly) of marketable securities, 
money, or both.
    (4) Value of assets. For purposes of section 731(c) and this 
section, the value of the assets of an entity is determined without 
regard to any debt that may encumber or otherwise be allocable to those 
assets, other than debt that is incurred to acquire an asset with a 
principal purpose of avoiding or reducing the effect of section 731(c) 
and this section.
    (d) Exceptions--(1) In general. Except as otherwise provided in 
paragraph (d)(2) of this section, section 731(c) and this section do not 
apply to the distribution of a marketable security if--
    (i) The security was contributed to the partnership by the 
distributee partner;
    (ii) The security was acquired by the partnership in a 
nonrecognition transaction, and the following conditions are satisfied--
    (A) The value of any marketable securities and money exchanged by 
the partnership in the nonrecognition transaction is less than 20 
percent of the value of all the assets exchanged by the partnership in 
the nonrecognition transaction; and
    (B) The partnership distributed the security within five years of 
either the date the security was acquired by the partnership or, if 
later, the date the security became marketable; or
    (iii) The security was not a marketable security on the date 
acquired by the partnership, and the following conditions are 
satisfied--
    (A) The entity that issued the security had no outstanding 
marketable securities at the time the security was acquired by the 
partnership;
    (B) The security was held by the partnership for at least six months 
before the date the security became marketable; and
    (C) The partnership distributed the security within five years of 
the date the security became marketable.
    (2) Anti-stuffing rule. Paragraph (d)(1) of this section does not 
apply to the extent that 20 percent or more of the value of the 
distributed security is attributable to marketable securities or money 
contributed (directly or indirectly) by the partnership to the entity to 
which the distributed security relates after the security was acquired 
by the partnership (other than marketable securities contributed by the 
partnership that were originally contributed to the partnership by the 
distributee partner). For purposes of this paragraph (d)(2), money 
contributed by the distributing partnership does not include any money 
deemed contributed

[[Page 428]]

by the partnership as a result of section 752.
    (3) Successor security. Section 731(c) and this section apply to the 
distribution of a marketable security acquired by the partnership in a 
nonrecognition transaction in exchange for a security the distribution 
of which immediately prior to the exchange would have been excepted 
under this paragraph (d) only to the extent that section 731(c) and this 
section otherwise would have applied to the exchanged security.
    (e) Investment partnerships--(1) In general. Section 731(c) and this 
section do not apply to the distribution of marketable securities by an 
investment partnership (as defined in section 731(c)(3)(C)(i)) to an 
eligible partner (as defined in section 731(c)(3)(C)(iii)).
    (2) Eligible partner--(i) Contributed services. For purposes of 
section 731(c)(3)(C)(iii) and this section, a partner is not treated as 
a partner other than an eligible partner solely because the partner 
contributed services to the partnership.
    (ii) Contributed partnership interests. For purposes of determining 
whether a partner is an eligible partner under section 731(c)(3)(C), if 
the partner has contributed to the investment partnership an interest in 
another partnership that meets the requirements of paragraph (e)(4)(i) 
of this section after the contribution, the contributed interest is 
treated as property specified in section 731(c)(3)(C)(i).
    (3) Trade or business activities. For purposes of section 
731(c)(3)(C) and this section, a partnership is not treated as engaged 
in a trade or business by reason of----
    (i) Any activity undertaken as an investor, trader, or dealer in any 
asset described in section 731(c)(3)(C)(i), including the receipt of 
commitment fees, break-up fees, guarantee fees, director's fees, or 
similar fees that are customary in and incidental to any activities of 
the partnership as an investor, trader, or dealer in such assets;
    (ii) Reasonable and customary management services (including the 
receipt of reasonable and customary fees in exchange for such management 
services) provided to an investment partnership (within the meaning of 
section 731(c)(3)(C)(i)) in which the partnership holds a partnership 
interest; or
    (iii) Reasonable and customary services provided by the partnership 
in assisting the formation, capitalization, expansion, or offering of 
interests in a corporation (or other entity) in which the partnership 
holds or acquires a significant equity interest (including the provision 
of advice or consulting services, bridge loans, guarantees of 
obligations, or service on a company's board of directors), provided 
that the anticipated receipt of compensation for the services, if any, 
does not represent a significant purpose for the partnership's 
investment in the entity and is incidental to the investment in the 
entity.
    (4) Partnership tiers. For purposes of section 731(c)(3)(C)(iv) and 
this section, a partnership (upper-tier partnership) is not treated as 
engaged in a trade or business engaged in by, or as holding (instead of 
a partnership interest) a proportionate share of the assets of, a 
partnership (lower-tier partnership) in which the partnership holds a 
partnership interest if----
    (i) The upper-tier partnership does not actively and substantially 
participate in the management of the lower-tier partnership; and
    (ii) The interest held by the upper-tier partnership is less than 20 
percent of the total profits and capital interests in the lower-tier 
partnership.
    (f) Basis rules--(1) Partner's basis--(i) Partner's basis in 
distributed securities. The distributee partner's basis in distributed 
marketable securities with respect to which gain is recognized by reason 
of section 731(c) and this section is the basis of the security 
determined under section 732, increased by the amount of such gain. Any 
increase in the basis of the marketable securities attributable to gain 
recognized by reason of section 731(c) and this section is allocated to 
marketable securities in proportion to their respective amounts of 
unrealized appreciation in the hands of the partner before such 
increase.
    (ii) Partner's basis in partnership interest. The basis of the 
distributee partner's interest in the partnership is determined under 
section 733 as if no gain were recognized by the partner on the

[[Page 429]]

distribution by reason of section 731(c) and this section.
    (2) Basis of partnership property. No adjustment is made to the 
basis of partnership property under section 734 as a result of any gain 
recognized by a partner, or any step-up in the basis in the distributed 
marketable securities in the hands of the distributee partner, by reason 
of section 731(c) and this section.
    (g) Coordination with other sections--(1) Sections 704(c)(1)(B) and 
737--(i) In general. If a distribution results in the application of 
sections 731(c) and one or both of sections 704(c)(1)(B) and 737, the 
effect of the distribution is determined by applying section 
704(c)(1)(B) first, section 731(c) second, and finally section 737.
    (ii) Section 704(c)(1)(B). The basis of the distributee partner's 
interest in the partnership for purposes of determining the amount of 
gain, if any, recognized by reason of section 731(c) (and for 
determining the basis of the marketable securities in the hands of the 
distributee partner) includes the increase or decrease, if any, in the 
partner's basis that occurs under section 704(c)(1)(B)(iii) as a result 
of a distribution to another partner of property contributed by the 
distributee partner in a distribution that is part of the same 
distribution as the marketable securities.
    (iii) Section 737--(A) Marketable securities as other property. A 
distribution of marketable securities is treated as a distribution of 
property other than money for purposes of section 737 to the extent that 
the marketable securities are not treated as money under section 731(c). 
In addition, marketable securities contributed to the partnership are 
treated as property other than money in determining the contributing 
partner's net precontribution gain under section 737(b).
    (B) Basis increase under section 737. The basis of the distributee 
partner's interest in the partnership for purposes of determining the 
amount of gain, if any, recognized by reason of section 731(c) (and for 
determining the basis of the marketable securities in the hands of the 
distributee partner) does not include the increase, if any, in the 
partner's basis that occurs under section 737(c)(1) as a result of a 
distribution of property to the distributee partner in a distribution 
that is part of the same distribution as the marketable securities.
    (2) Section 708(b)(1)(B). If a partnership termination occurs under 
section 708(b)(1)(B), the successor partnership will be treated as if 
there had been no termination for purposes of section 731(c) and this 
section. Accordingly, a section 708(b)(1)(B) termination will not affect 
whether a partnership qualifies for any of the exceptions in paragraphs 
(d) and (e) of this section. In addition, a deemed distribution that may 
occur as a result of a section 708(b)(1)(B) termination will not be 
subject to section 731(c) and this section.
    (h) Anti-abuse rule. The provisions of section 731(c) and this 
section must be applied in a manner consistent with the purpose of 
section 731(c) and the substance of the transaction. Accordingly, if a 
principal purpose of a transaction is to achieve a tax result that is 
inconsistent with the purpose of section 731(c) and this section, the 
Commissioner can recast the transaction for Federal tax purposes as 
appropriate to achieve tax results that are consistent with the purpose 
of section 731(c) and this section. Whether a tax result is inconsistent 
with the purpose of section 731(c) and this section must be determined 
based on all the facts and circumstances. For example, under the 
provisions of this paragraph (h)--
    (1) A change in partnership allocations or distribution rights with 
respect to marketable securities may be treated as a distribution of the 
marketable securities subject to section 731(c) if the change in 
allocations or distribution rights is, in substance, a distribution of 
the securities;
    (2) A distribution of substantially all of the assets of the 
partnership other than marketable securities and money to some partners 
may also be treated as a distribution of marketable securities to the 
remaining partners if the distribution of the other property and the 
withdrawal of the other partners is, in substance, equivalent to a 
distribution of the securities to the remaining partners; and

[[Page 430]]

    (3) The distribution of multiple properties to one or more partners 
at different times may also be treated as part of a single distribution 
if the distributions are part of a single plan of distribution.
    (i) [Reserved]
    (j) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, all securities held by a 
partnership are marketable securities within the meaning of section 
731(c); the partnership holds no marketable securities other than the 
securities described in the example; all distributions by the 
partnership are subject to section 731(a) and are not subject to 
sections 704(c)(1)(B), 707(a)(2)(B), 751(b), or 737; and no securities 
are eligible for an exception to section 731(c). The examples are as 
follows:

    Example 1. Recognition of gain. (i) A and B form partnership AB as 
equal partners. A contributes property with a fair market value of 
$1,000 and an adjusted tax basis of $250. B contributes $1,000 cash. AB 
subsequently purchases Security X for $500 and immediately distributes 
the security to A in a current distribution. The basis in A's interest 
in the partnership at the time of distribution is $250.
    (ii) The distribution of Security X is treated as a distribution of 
money in an amount equal to the fair market value of Security X on the 
date of distribution ($500). (The amount of the distribution that is 
treated as money is not reduced under section 731(c)(3)(B) and paragraph 
(b) of this section because, if Security X had been sold immediately 
before the distribution, there would have been no gain recognized by AB 
and A's distributive share of the gain would therefore have been zero.) 
As a result, A recognizes $250 of gain under section 731(a)(1) on the 
distribution ($500 distribution of money less $250 adjusted tax basis in 
A's partnership interest).
    Example 2. Reduction in amount treated as money--in general. (i) A 
and B form partnership AB as equal partners. AB subsequently distributes 
Security X to A in a current distribution. Immediately before the 
distribution, AB held securities with the following fair market values, 
adjusted tax bases, and unrecognized gain or loss:

------------------------------------------------------------------------
                                                                   Gain 
                                                Value    Basis    (Loss)
------------------------------------------------------------------------
Security X...................................      100       70       30
Security Y...................................      100       80       20
Security Z...................................      100      110     (10)
------------------------------------------------------------------------

    (ii) If AB had sold the securities for fair market value immediately 
before the distribution to A, the partnership would have recognized $40 
of net gain ($30 gain on Security X plus $20 gain on Security Y minus 
$10 loss on Security Z). A's distributive share of this gain would have 
been $20 (one-half of $40 net gain). If AB had sold the remaining 
securities immediately after the distribution of Security X to A, the 
partnership would have $10 of net gain ($20 of gain on Security Y minus 
$10 loss on Security Z). A's distributive share of this gain would have 
been $5 (one-half of $10 net gain). As a result, the distribution 
resulted in a decrease of $15 in A's distributive share of the net gain 
in AB's securities ($20 net gain before distribution minus $5 net gain 
after distribution).
    (iii) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $15. The distribution of Security X is therefore treated as a 
distribution of $85 of money to A ($100 fair market value of Security X 
minus $15 reduction).
    Example 3. Reduction in amount treated as money--carried interest. 
(i) A and B form partnership AB. A contributes $1,000 and provides 
substantial services to the partnership in exchange for a 60 percent 
interest in partnership profits. B contributes $1,000 in exchange for a 
40 percent interest in partnership profits. AB subsequently distributes 
Security X to A in a current distribution. Immediately before the 
distribution, AB held securities with the following fair market values, 
adjusted tax bases, and unrecognized gain:

------------------------------------------------------------------------
                                                Value    Basis     Gain 
------------------------------------------------------------------------
Security X...................................      100       80       20
Security Y...................................      100       90       10
------------------------------------------------------------------------

    (ii) If AB had sold the securities for fair market value immediately 
before the distribution to A, the partnership would have recognized $30 
of net gain ($20 gain on Security X plus $10 gain on Security Y). A's 
distributive share of this gain would have been $18 (60 percent of $30 
net gain). If AB had sold the remaining securities immediately after the 
distribution of Security X to A, the partnership would have $10 of net 
gain ($10 gain on Security Y). A's distributive share of this gain would 
have been $6 (60 percent of $10 net gain). As a result, the distribution 
resulted in a decrease of $12 in A's distributive share of the net gain 
in AB's securities ($18 net gain before distribution minus $6 net gain 
after distribution).
    (iii) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $12. The distribution of Security X is therefore treated as a 
distribution of $88 of money to A ($100 fair market value of Security X 
minus $12 reduction).

[[Page 431]]

    Example 4. Reduction in amount treated as money--change in 
partnership allocations. (i) A is admitted to partnership ABC as a 
partner with a 1 percent interest in partnership profits. At the time of 
A's admission, ABC held no securities. ABC subsequently acquires 
Security X. A's interest in partnership profits is subsequently 
increased to 2 percent for securities acquired after the increase. A 
retains a 1 percent interest in all securities acquired before the 
increase. ABC then acquires Securities Y and Z and later distributes 
Security X to A in a current distribution. Immediately before the 
distribution, the securities held by ABC had the following fair market 
values, adjusted tax bases, and unrecognized gain or loss:

------------------------------------------------------------------------
                                                                   Gain 
                                                Value    Basis    (Loss)
------------------------------------------------------------------------
Security X...................................    1,000      500      500
Security Y...................................    1,000      800      200
Security Z ..................................    1,000    1,100    (100)
------------------------------------------------------------------------

    (ii) If ABC had sold the securities for fair market value 
immediately before the distribution to A, the partnership would have 
recognized $600 of net gain ($500 gain on Security X plus $200 gain on 
Security Y minus $100 loss on Security Z). A's distributive share of 
this gain would have been $7 (1 percent of $500 gain on Security X plus 
2 percent of $200 gain on Security Y minus 2 percent of $100 loss on 
Security Z).
    (iii) If ABC had sold the remaining securities immediately after the 
distribution of Security X to A, the partnership would have $100 of net 
gain ($200 gain on Security Y minus $100 loss on Security Z). A's 
distributive share of this gain would have been $2 (2 percent of $200 
gain on Security Y minus 2 percent of $100 loss on Security Z). As a 
result, the distribution resulted in a decrease of $5 in A's 
distributive share of the net gain in ABC's securities ($7 net gain 
before distribution minus $2 net gain after distribution).
    (iv) Under paragraph (b) of this section, the amount of the 
distribution of Security X that is treated as a distribution of money is 
reduced by $5. The distribution of Security X is therefore treated as a 
distribution of $995 of money to A ($1000 fair market value of Security 
X minus $5 reduction).
    Example 5. Basis consequences--distribution of marketable security. 
(i) A and B form partnership AB as equal partners. A contributes 
nondepreciable real property with a fair market value and adjusted tax 
basis of $100.
    (ii) AB subsequently distributes Security X with a fair market value 
of $120 and an adjusted tax basis of $90 to A in a current distribution. 
At the time of distribution, the basis in A's interest in the 
partnership is $100. The amount of the distribution that is treated as 
money is reduced under section 731(c)(3)(B) and paragraph (b)(2) of this 
section by $15 (one-half of $30 net gain in Security X). As a result, A 
recognizes $5 of gain under section 731(a) on the distribution (excess 
of $105 distribution of money over $100 adjusted tax basis in A's 
partnership interest).
    (iii) A's adjusted tax basis in Security X is $95 ($90 adjusted 
basis of Security X determined under section 732(a)(1) plus $5 of gain 
recognized by A by reason of section 731(c)). The basis in A's interest 
in the partnership is $10 as determined under section 733 ($100 pre-
distribution basis minus $90 basis allocated to Security X under section 
732).
    Example 6. Basis consequences--distribution of marketable security 
and other property. (i) A and B form partnership AB as equal partners. A 
contributes nondepreciable real property, with a fair market value of 
$100 and an adjusted tax basis of $10.
    (ii) AB subsequently distributes Security X with a fair market value 
and adjusted tax basis of $40 to A in a current distribution and, as 
part of the same distribution, AB distributes Property Z to A with an 
adjusted tax basis and fair market value of $40. At the time of 
distribution, the basis in A's interest in the partnership is $10. A 
recognizes $30 of gain under section 731(a) on the distribution (excess 
of $40 distribution of money over $10 adjusted tax basis in A's 
partnership interest).
    (iii) A's adjusted tax basis in Security X is $35 ($5 adjusted basis 
determined under section 732(a)(2) plus $30 of gain recognized by A by 
reason of section 731(c)). A's basis in Property Z is $5, as determined 
under section 732(a)(2). The basis in A's interest in the partnership is 
$0 as determined under section 733 ($10 pre-distribution basis minus $10 
basis allocated between Security X and Property Z under section 732).
    (iv) AB's adjusted tax basis in the remaining partnership assets is 
unchanged unless the partnership has a section 754 election in effect. 
If AB made such an election, the aggregate basis of AB's assets would be 
increased by $70 (the difference between the $80 combined basis of 
Security X and Property Z in the hands of the partnership before the 
distribution and the $10 combined basis of the distributed property in 
the hands of A under section 732 after the distribution). Under section 
731(c)(5), no adjustment is made to partnership property under section 
734 as a result of any gain recognized by A by reason of section 731(c) 
or as a result of any step-up in basis in the distributed marketable 
securities in the hands of A by reason of section 731(c).
    Example 7. Coordination with section 737. (i) A and B form 
partnership AB. A contributes Property A, nondepreciable real property 
with a fair market value of $200 and an adjusted basis of $100 in 
exchange for a 25 percent interest in partnership capital and profits. 
AB owns marketable Security X.

[[Page 432]]

    (ii) Within five years of the contribution of Property A, AB 
subsequently distributes Security X, with a fair market value of $120 
and an adjusted tax basis of $100, to A in a current distribution that 
is subject to section 737. As part of the same distribution, AB 
distributes Property Y to A with a fair market value of $20 and an 
adjusted tax basis of $0. At the time of distribution, there has been no 
change in the fair market value of Property A or the adjusted tax basis 
in A's interest in the partnership.
    (iii) If AB had sold Security X for fair market value immediately 
before the distribution to A, the partnership would have recognized $20 
of gain. A's distributive share of this gain would have been $5 (25 
percent of $20 gain). Because AB has no other marketable securities, A's 
distributive share of gain in partnership securities after the 
distribution would have been $0. As a result, the distribution resulted 
in a decrease of $5 in A's share of the net gain in AB's securities ($5 
net gain before distribution minus $0 net gain after distribution). 
Under paragraph (b)(2) of this section, the amount of the distribution 
of Security X that is treated as a distribution of money is reduced by 
$5. The distribution of Security X is therefore treated as a 
distribution of $115 of money to A ($120 fair market value of Security X 
minus $5 reduction). The portion of the distribution of the marketable 
security that is not treated as a distribution of money ($5) is treated 
as other property for purposes of section 737.
    (iv) A recognizes total gain of $40 on the distribution. A 
recognizes $15 of gain under section 731(a)(1) on the distribution of 
the portion of Security X treated as money ($115 distribution of money 
less $100 adjusted tax basis in A's partnership interest). A recognizes 
$25 of gain under section 737 on the distribution of Property Y and the 
portion of Security X that is not treated as money. A's section 737 gain 
is equal to the lesser of (i) A's precontribution gain ($100) or (ii) 
the excess of the fair market value of property received ($20 fair 
market value of Property Y plus $5 portion of Security X not treated as 
money) over the adjusted basis in A's interest in the partnership 
immediately before the distribution ($100) reduced (but not below zero) 
by the amount of money received in the distribution ($115).
    (v) A's adjusted tax basis in Security X is $115 ($100 basis of 
Security X determined under section 732(a) plus $15 of gain recognized 
by reason of section 731(c)). A's adjusted tax basis in Property Y is $0 
under section 732(a). The basis in A's interest in the partnership is 
$25 ($100 basis before distribution minus $100 basis allocated to 
Security X under section 732(a) plus $25 gain recognized under section 
737).
    (k) Effective date. This section applies to distributions made on or 
after December 26, 1996. However, taxpayers may apply the rules of this 
section to distributions made after December 8, 1994, and before 
December 26, 1996.

[T.D. 8707, 61 FR 67938, Dec. 26, 1996; 62 FR 8086, Feb. 21, 1997]



Sec. 1.732-1   Basis of distributed property other than money.

    (a) Distributions other than in liquidation of a partner's interest. 
The basis of property (other than money) received by a partner in a 
distribution from a partnership, other than in liquidation of his entire 
interest, shall be its adjusted basis to the partnership immediately 
before such distribution. However, the basis of the property to the 
partner shall not exceed the adjusted basis of the partner's interest in 
the partnership, reduced by the amount of any money distributed to him 
in the same transaction. The provisions of this paragraph may be 
illustrated by the following examples:

    Example 1. Partner A, with an adjusted basis of $15,000 for his 
partnership interest, receives in a current distribution property having 
an adjusted basis of $10,000 to the partnership immediately before 
distribution, and $2,000 cash. The basis of the property in A's hands 
will be $10,000. Under sections 733 and 705, the basis of A's 
partnership interest will be reduced by the distribution to $3,000 
($15,000 less $2,000 cash, less $10,000, the basis of the distributed 
property to A).
    Example 2. Partner R has an adjusted basis of $10,000 for his 
partnership interest. He receives a current distribution of $4,000 cash 
and property with an adjusted basis to the partnership of $8,000. The 
basis of the distributed property to partner R is limited to $6,000 
($10,000, the adjusted basis of his interest, reduced by $4,000, the 
cash distributed).

    (b) Distribution in liquidation. Where a partnership distributes 
property (other than money) in liquidation of a partner's entire 
interest in the partnership, the basis of such property to the partner 
shall be an amount equal to the adjusted basis of his interest in the 
partnership reduced by the amount of any money distributed to him in the 
same transaction. Application of this rule may be illustrated by the 
following example:

    Example. Partner B, with a partnership interest having an adjusted 
basis to him of $12,000, retires from the partnership and receives cash 
of $2,000, and real property with

[[Page 433]]

an adjusted basis to the partnership of $6,000 and a fair market value 
of $14,000. The basis of the real property to B is $10,000 (B's basis 
for his partnership interest, $12,000, reduced by $2,000, the cash 
distributed).

    (c) Allocation of basis among properties distributed to a partner. 
(1) Under section 732 (a)(2) or (b), the basis to be allocated to 
properties distributed to a partner shall be allocated first to any 
unrealized receivables (as defined in section 751(c)) and inventory 
items (as defined in section 751(d)(2)) included in the distribution. 
However, such receivables or inventory items may not take a higher basis 
in the hands of the partner than their common adjusted basis to the 
partnership immediately before the distribution, unless such 
distribution is treated as a sale or exchange under section 751(b), or 
unless the distributee partner has a special basis adjustment for the 
distributed property under section 732(d) or 743(b). Any basis not 
allocated to unrealized receivable or inventory items shall be allocated 
to any other properties distributed to the partner in the same 
transaction, in proportion to the bases of such other properties in the 
hands of the partnership before distribution. The provisions of this 
subparagraph may be illustrated by the following example:

    Example. Partner A, whose partnership interest in partnership ABC 
has an adjusted basis of $15,000, receives as a distribution in 
liquidation of his entire interest inventory items having a basis to the 
partnership of $6,000. In addition, he receives cash of $5,000, and two 
parcels of real property with adjusted bases to the partnership of 
$6,000 and $2,000, respectively. Basis in the amount of $10,000 ($15,000 
basis, less $5,000 cash received) is allocated $6,000 to inventory 
items, and $3,000 (6,000/8,000 x $4,000) and $1,000 (2,000/
8,000 x $4,000), respectively, to the two parcels of real property.

    (2) If the adjusted basis to the partnership of the unrealized 
receivables and inventory items distributed to a partner is greater than 
the partner's adjusted basis of his interest (reduced by the amount of 
money distributed to him in the same transaction), the amount of the 
basis to be allocated to such unrealized receivables and inventory items 
shall be allocated in proportion to the adjusted bases of such 
properties in the hands of the partnership. If the basis of the 
partner's interest to be allocated upon a distribution in liquidation of 
his entire interest is in excess of the adjusted basis to the 
partnership of the unrealized receivables and inventory items 
distributed, and if there is no other property distributed to which such 
excess can be allocated, the distributee partner sustains a capital loss 
under section 731(a)(2) to the extent of the unallocated basis of his 
partnership interest. The provisions of this subparagraph may be 
illustrated by the following examples:

    Example 1. Partner C, whose interest in partnership ABC has an 
adjusted basis to him of $9,000, receives as a distribution in 
liquidation cash of $6,000, inventory items having an adjusted basis to 
the partnership of $6,000, and real property having a basis to the 
partnership of $4,000. The cash payment reduces C's basis to $3,000, 
which is allocated entirely to inventory items. The real property has a 
zero basis in C's hands. The partnership bases not carried over to C for 
the distributed properties are lost unless an election under section 754 
is in effect requiring the partnership to adjust the bases of remaining 
partnership properties under section 734(b).
    Example 2. Partner B, whose interest in partnership ABC has an 
adjusted basis to him of $9,000, receives as a distribution in 
liquidation cash of $1,000 and inventory items having a basis to the 
partnership of $6,000. The cash payment reduces B's basis to $8,000, 
which can be allocated only to the extent of $6,000 to the inventory 
items. The remaining $2,000 basis, not allocable to distributed 
property, constitutes a capital loss in that amount to partner B under 
section 731(a)(2). If the election under section 754 is in effect, see 
section 734(b) for adjustment of the basis of undistributed partnership 
property.

    (d) Special partnership basis to transferee under section 732(d). 
(1)(i) A transfer of a partnership interest occurs upon a sale or 
exchange of an interest or upon the death of a partner. Section 732(d) 
provides a special rule for the determination of the basis of property 
distributed to a transferee partner who acquired any part of his 
partnership interest in a transfer with respect to which the election 
under section 754 (relating to the optional adjustment to basis of 
partnership property) was not in effect.
    (ii) Where an election under section 754 is in effect, see section 
743(b) and paragraph (b) of Sec. 1.743-1 and Sec. 1.732-2.

[[Page 434]]

    (iii) If a transferee partner receives a distribution of property 
(other than money) from the partnership within 2 years after he acquired 
his interest or part thereof in the partnership by a transfer with 
respect to which the election under section 754 was not in effect, he 
may elect to treat as the adjusted partnership basis of such property 
the adjusted basis such property would have if the adjustment provided 
in section 743(b) were in effect.
    (iv) If an election under section 732(d) is made upon a distribution 
of property to a transferee partner, the amount of the adjustment with 
respect to the transferee partner is not diminished by any depletion or 
depreciation of that portion of the basis of partnership property which 
arises from the special basis adjustment under section 732(d), since 
depletion or depreciation on such portion for the period prior to 
distribution is allowed or allowable only if the optional adjustment 
under section 743(b) is in effect.
    (v) If property is distributed to a transferee partner who elects 
under section 732(d), and if such property is not the same property 
which would have had a special basis adjustment, then such special basis 
adjustment shall apply to any like property received in the 
distribution, provided that the transferee, in exchange for the property 
distributed, has relinquished his interest in the property with respect 
to which he would have had a special basis adjustment. This rule applies 
whether the property in which the transferee has relinquished his 
interest is retained or disposed or by the partnership. (For shift of 
transferee's special basis adjustment to like property, see paragraph 
(b)(2)(ii) of Sec. 1.743-1.)
    (vi) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. The basis to transferee partner K of his one-fourth 
interest in partnership WJKS is $17,000. At the time he acquired such 
interest by purchase, the election under section 754 was not in effect 
and the partnership inventory had a basis to the partnership of $14,000 
and a value of $16,000. K's purchase price reflected $500 of this 
difference. Thus, $4,000 of the $17,000 paid by K for his one-fourth 
interest was attributable to his share of partnership inventory with a 
basis of $3,500. Within 2 years after acquiring his interest, K retired 
from the partnership and received in liquidation of his entire interest 
cash of $1,500, inventory with a basis to the partnership of $3,500, 
property X (a capital asset), with an adjusted basis to the partnership 
of $2,000, and property Y (a depreciable asset), with an adjusted basis 
to the partnership of $4,000. The value of the inventory received by K 
was one-fourth of the value of all partnership inventory and was his 
share of such property. It is immaterial whether the inventory K 
received was on hand when K acquired his interest. In accordance with 
K's election under section 732(d), the amount of his share of 
partnership basis which is attributable to partnership inventory is 
increased by $500 (one-fourth of the $2,000 difference between the value 
of such property, $16,000, and its $14,000 basis to the partnership at 
the time K acquired his interest). This adjustment under section 732(d) 
applies only for purposes of distributions to partner K, and not for 
purposes of partnership depreciation, depletion, or gain or loss on 
disposition. Thus, the amount to be allocated among the properties 
received by K in the liquidating distribution is $15,500 ($17,000, K's 
basis for his interest, reduced by the amount of cash received, $1,500). 
This amount is allocated as follows: The basis of the inventory items 
received is $4,000, consisting of the $3,500 common partnership basis 
for such items, plus the special basis adjustment of $500 which K would 
have had under section 743(b). The remaining basis of $11,500 ($15,500 
minus $4,000) is to be allocated to the remaining property distributed 
to K in proportion to their adjusted bases to the partnership. Since the 
adjusted basis to the partnership of property X is $2,000, and that of 
property Y is $4,000, the $11,500 is allocated $3,833 (2,000/
6,000 x $11,500) to X, and $7,667 (4,000/6,000 x $11,500) to Y.

    (2) A transferee partner who wishes to elect under section 732(d) 
shall make the election with his tax return:
    (i) For the year of the distribution, if the distribution includes 
any property subject to the allowance for depreciation, depletion, or 
amortization, or
    (ii) For any taxable year no later than the first taxable year in 
which the basis of any of the distributed property is pertinent in 
determining his income tax, if the distribution does not include any 
such property subject to the allowance for depreciation, depletion or 
amortization.
    (3) A taxpayer making an election under section 732(d) shall submit 
with the return in which the election is made a schedule setting forth 
the following:

[[Page 435]]

    (i) That under section 732(d) he elects to adjust the basis of 
property received in a distribution; and
    (ii) The computation of the special basis adjustment for the 
property distributed and the properties to which the adjustment has been 
allocated. For rules of allocation, see section 755.
    (4) A partner who acquired any part of his partnership interest in a 
transfer to which the election provided in section 754 was not in 
effect, is required to apply the special basis rule contained in section 
732(d) to a distribution to him, whether or not made within 2 years 
after the transfer, if at the time of his acquisition of the transferred 
interest:
    (i) The fair market value of all partnership property (other than 
money) exceeded 110 percent of its adjusted basis to the partnership.
    (ii) An allocation of basis under section 732(c) upon a liquidation 
of his interest immediately after the transfer of the interest would 
have resulted in a shift of basis from property not subject to an 
allowance for depreciation, depletion, or amortization, to property 
subject to such an allowance, and
    (iii) A special basis adjustment under section 743(b) would change 
the basis to the transferee partner of the property actually 
distributed.

The application of the rule presented in this subparagraph may be 
illustrated by the following examples:

    Example 1. Partnership ABC owns three parcels of land, each of which 
has an adjusted basis to the partnership of $5,000 and is worth $55,000, 
and depreciable property with an adjusted basis and value of $150,000. D 
purchases A's partnership interest for $105,000 when the election under 
section 754 is not in effect. At the time of D's purchase, the fair 
market value of all partnership property (other than money) is $315,000, 
which exceeds 110 percent of $165,000, its adjusted basis to the 
partnership. Four years later, the partnership is dissolved. D receives 
one of the three parcels of land which has a basis to the partnership of 
$5,000, and one-third of the depreciable property with an adjusted basis 
to the partnership at that time of $45,000, one-third of $135,000 
($150,000 basis, minus $15,000 depreciation computed on the partnership 
basis. See subparagraph (1)(iv) of this paragraph.) If D's adjusted 
basis for his interest at the time of the distribution was $100,000 and 
was allocated under section 732(c) to the property received by him in 
proportion to their respective bases to the partnership, the basis to 
him for the distributed land would be $10,000 (5,000/50,000 x $100,000) 
and the basis of the depreciable property would be $90,000 (45,000/
50,000 x $100,000). In effect, D would be attributing to the basis of 
the depreciable property a portion of the cost of his partnership 
interest properly attributable to appreciation in nondepreciable 
property. The application of section 743(b) to the transfer of the 
interest would have resulted in a different basis to D for the property 
actually distributed. Therefore, the special basis adjustment under 
section 732(d) must be made so that D must increase the basis of the 
land by a special basis adjustment of $50,000 ($55,000 fair market value 
less $5,000 partnership basis), making the basis of his interest therein 
$55,000 (55,000/100,000 x  $100,000). D's basis for the depreciable 
property will then be $45,000 (45,000/100,000  x $100,000).
    Example 2. Assume the same facts as in example 1 of this 
subparagraph, except that the partnership does not dissolve but 
distributes one parcel of land to each of the partners in a current 
distribution. Since the conditions of this subparagraph have been met, 
D's basis for the distributed land is the adjusted basis such land would 
have if the adjustment provided in section 743(b) were in effect with 
respect to the partnership property. Therefore, D's basis for the land 
is $55,000 ($5,000 basis of the land to the partnership, plus $50,000 
special basis adjustment under section 732(d)). D's basis for his 
partnership interest is reduced by $55,000, his basis for the property 
distributed.

    (e) Exception. When a partnership distributes unrealized receivables 
(as defined in section 751(c)) or substantially appreciated inventory 
items (as defined in section 751(d)) in exchange for any part of a 
partner's interest in other partnership property (including money), or, 
conversely, partnership property (including money) other than unrealized 
receivables or substantially appreciated inventory items in exchange for 
any part of a partner's interest in the partnership's unrealized 
receivables or substantially appreciated inventory items, the 
distribution will be treated as a sale or exchange of property under the 
provisions of section 751(b). In such case, section 732 (including 
subsection(d) thereof) applies in determining the partner's basis of the 
property which he is treated as having sold to or exchanged with the 
partnership (as constituted after the distribution). The

[[Page 436]]

partner is considered as having received such property in a current 
distribution and, immediately thereafter, as having sold or exchanged 
it. See section 751(b) and paragraph (b) of Sec. 1.751-1. However, 
section 732 does not apply in determining the basis of that part of 
property actually distributed to a partner which is treated as received 
by him in a sale or exchange under section 751(b). Consequently, the 
basis of such property shall be its cost to the partner.



Sec. 1.732-2   Special partnership basis of distributed property.

    (a) Adjustments under section 734(b). In the case of a distribution 
of property to a partner, the partnership bases of the distributed 
properties shall reflect any increases or decreases to the basis of 
partnership property which have been made previously under section 
734(b) (relating to the optional adjustment to basis of undistributed 
partnership property) in connection with previous distributions.
    (b) Adjustments under section 743(b). In the case of a distribution 
of property to a partner who acquired any part of his interest in a 
transfer as to which an election under section 754 was in effect, then, 
for the purposes of section 732 (other than subsection (d) thereof), the 
adjusted partnership bases of the distributed property shall take into 
account, in addition to any adjustments under section 734(b), the 
transferee's special basis adjustment for the distributed property under 
section 743(b). The application of this paragraph may be illustrated by 
the following example:

    Example. Partner D acquired his interest in partnership ABD from a 
previous partner. Since the partnership had made an election under 
section 754, a special basis adjustment with respect to D is applicable 
to the basis of partnership property in accordance with section 743(b). 
One of the assets of the partnership at the time D acquired his interest 
was property X, which is later distributed to D in a current 
distribution. Property X has an adjusted basis to the partnership of 
$1,000 and with respect to D it has a special basis adjustment of $500. 
Therefore, for purposes of section 732(a)(1), the adjusted basis of such 
property to the partnership with respect to D immediately before its 
distribution is $1,500. However, if property X is distributed to partner 
A, a nontransferee partner, its adjusted basis to the partnership for 
purposes of section 732(a)(1) is only $1,000. In such case, D's $500 
special basis adjustment may shift over to other property. See paragraph 
(b)(2)(ii) of Sec. 1.743-1.

    (c) Adjustments to basis of distributed inventory and unrealized 
receivables. Under section 732, the basis to be allocated to distributed 
properties shall be allocated first to any unrealized receivables and 
inventory items. If the distributee partner is a transferee of a 
partnership interest and has a special basis adjustment for unrealized 
receivables or inventory items under either section 743(b) or section 
732(d), then the partnership adjusted basis immediately prior to 
distribution of any unrealized receivables or inventory items 
distributed to such partner shall be determined as follows: If the 
distributee partner receives his entire share of the fair market value 
of the inventory items or unrealized receivables of the partnership, the 
adjusted basis of such distributed property to the partnership, for the 
purposes of section 732, shall take into account the entire amount of 
any special basis adjustment which the distributee partner may have for 
such assets. If the distributee partner receives less than his entire 
share of the fair market value of partnership inventory items or 
unrealized receivables, then, for purposes of section 732, the adjusted 
basis of such distributed property to the partnership shall take into 
account the same proportion of the distributee's special basis 
adjustment for unrealized receivables or inventory items as the value of 
such items distributed to him bears to his entire share of the total 
value of all such items of the partnership. The provisions of this 
paragraph may be illustrated by the following example:

    Example. Partner C acquired his 40-percent interest in partnership 
AC from a previous partner. Since the partnership had made an election 
under section 754, C has a special basis adjustment to partnership 
property under section 743(b). C retires from the partnership when the 
adjusted basis of his partnership interest is $3,000. He receives from 
the partnership in liquidation of his entire interest, $1,000 cash, 
certain capital assets, depreciable property, and certain inventory 
items and unrealized receivables. C has a special basis adjustment of 
$800 with respect to partnership inventory items and of $200

[[Page 437]]

with respect to unrealized receivables. The common partnership basis for 
the inventory items distributed to him is $500 and for the unrealized 
receivables is zero. If the value of inventory items and the unrealized 
receivables distributed to C in his 40 percent share of the total value 
of all partnership inventory items and unrealized receivables, then, for 
purposes of section 732, the adjusted basis of such property in C's 
hands will be $1,300 for the inventory items ($500 plus $800) and $200 
for the unrealized receivables (zero plus $200). The remaining basis of 
$500, which constitutes the basis of the capital assets and depreciable 
property distributed to C, is determined as follows: $3,000 (total 
basis) less $1,000 cash, or $2,000 (the amount to be allocated to the 
basis of all distributed property), less $1,500 ($800 and $200 special 
basis adjustments, plus $500 common partnership basis, the amount 
allocated to inventory items and unrealized receivables). However, if 
the value of the inventory items and unrealized receivables distributed 
to C consisted of only 20 percent of the total fair market value of such 
property (i. e., only one-half of C's 40-percent share), then only one-
half of C's special basis adjustment of $800 for partnership inventory 
items and $200 for unrealized receivables would be taken into account. 
In that case, the basis of the inventory items in C's hands would be 
$650 ($250, the common partnership basis for inventory items distributed 
to him, plus $400, one-half of C's special basis adjustment for 
inventory items). The basis of the unrealized receivables in C's hands 
would be $100 (zero plus $100, one-half of C's special basis adjustment 
for unrealized receivables).



Sec. 1.733-1   Basis of distributee partner's interest.

    In the case of a distribution by a partnership to a partner other 
than in liquidation of a partner's entire interest, the adjusted basis 
to such partner of his interest in the partnership shall be reduced (but 
not below zero) by the amount of any money distributed to such partner 
and by the amount of the basis to him of distributed property other than 
money as determined under section 732 and Secs. 1.732-1 and 1.732-2.



Sec. 1.734-1   Optional adjustment to basis of undistributed partnership property.

    (a) General rule. A partnership shall not adjust the basis of 
partnership property as the result of a distribution of property to a 
partner, unless the election provided in section 754 (relating to 
optional adjustment to basis of partnership property) is in effect.
    (b) Method of adjustment--(1) Increase in basis. Where an election 
under section 754 is in effect and a distribution of partnership 
property is made, whether or not in liquidation of the partner's entire 
interest in the partnership, the adjusted basis of the remaining 
partnership assets shall be increased by:
    (i) The amount of any gain recognized under section 731(a)(1) to the 
distributee partner, or
    (ii) The excess of the adjusted basis to the partnership immediately 
before the distribution of any property distributed (including 
adjustments under section 743(b) or section 732(d) when applied) over 
the basis under section 732 (including such special basis adjustments) 
of such property to the distributee partner.

The provisions of this subparagraph may be illustrated by the following 
examples:

    Example 1. Partner A has a basis of $10,000 for his one-third 
interest in partnership ABC. The partnership has no liabilities and has 
assets consisting of cash of $11,000 and property with a partnership 
basis of $19,000 and a value of $22,000. A receives $11,000 in cash in 
liquidation of his entire interest in the partnership. He has a gain of 
$1,000 under section 731(a)(1). If the election under section 754 is in 
effect, the partnership basis for the property becomes $20,000 ($19,000 
plus $1,000).
    Example 2. Partner D has a basis of $10,000 for his one-third 
interest in partnership DEF. The partnership balance sheet before the 
distribution shows the following:

                                 Assets                                 
------------------------------------------------------------------------
                                          Adjusted basis       Value    
------------------------------------------------------------------------
Cash..................................      $4,000           $4,000     
Property X............................      11,000           11,000     
Property Y............................      15,000           18,000     
                                       ---------------------------------
    Total.............................      30,000           33,000     
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                          Adjusted basis       Value    
------------------------------------------------------------------------
Liabilities...........................          $0               $0     
Capital:                                                                
  D...................................      10,000           11,000     
  E...................................      10,000           11,000     
  F...................................      10,000           11,000     
                                       ---------------------------------
    Total.............................      30,000           33,000     
------------------------------------------------------------------------


[[Page 438]]

In liquidation of his entire interest in the partnership, D received 
property X with a partnership basis of $11,000. D's basis for property X 
is $10,000 under section 732(b). Where the election under section 754 is 
in effect, the excess of $1,000 (the partnership basis before the 
distribution less D's basis for property X after distribution) is added 
to the basis of property Y. The basis of property Y becomes $16,000 
($15,000 plus $1,000). If the distribution is made to a transferee 
partner who elects under section 732(d), see Sec. 1.734-2.

    (2) Decrease in basis. Where the election provided in section 754 is 
in effect and a distribution is made in liquidation of a partner's 
entire interest, the partnership shall decrease the adjusted basis of 
the remaining partnership property by:
    (i) The amount of loss, if any, recognized under section 731(a)(2) 
to the distributee partner, or
    (ii) The excess of the basis of the distributed property to the 
distributee, as determined under section 732 (including adjustments 
under section 743(b) or section 732(d) when applied) over the adjusted 
basis of such property to the partnership (including such special basis 
adjustments) immediately before such distribution.

The provisions of this subparagraph may be illustrated by the following 
examples:

    Example 1. Partner G has a basis of $11,000 for his one-third 
interest in partnership GHI. Partnership assets consist of cash of 
$10,000 and property with a basis of $23,000 and a value of $20,000. 
There are no partnership liabilities. In liquidation of his entire 
interest in the partnership, G receives $10,000 in cash. He has a loss 
of $1,000 under section 731(a)(2). If the election under section 754 is 
in effect, the partnership basis for the property becomes $22,000 
($23,000 less $1,000).
    Example 2. Partner J has a basis of $11,000 for his one-third 
interest in partnership JKL. The partnership balance sheet before the 
distribution shows the following:

                                 Assets                                 
------------------------------------------------------------------------
                                          Adjusted basis       Value    
------------------------------------------------------------------------
Cash..................................      $5,000           $5,000     
Property X............................      10,000           10,000     
Property Y............................      18,000           15,000     
                                       ---------------------------------
    Total.............................      33,000           30,000     
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                          Adjusted basis       Value    
------------------------------------------------------------------------
Liabilities...........................          $0               $0     
Capital:                                                                
  J...................................      11,000           10,000     
  K...................................      11,000           10,000     
  L...................................      11,000           10,000     
                                       ---------------------------------
    Total.............................      33,000           30,000     
------------------------------------------------------------------------

In liquidation of his entire interest in the partnership, J receives 
property X with a partnership basis of $10,000. J's basis for property X 
under section 732(b) is $11,000. Where the election under section 754 is 
in effect, the excess of $1,000 ($11,000 basis of property X to J, the 
distributee, less its $10,000 adjusted basis to the partnership 
immediately before the distribution) decreases the basis of property Y 
in the partnership. Thus, the basis of property Y becomes $17,000 
($18,000 less $1,000). If the distribution is made to a transferee 
partner who elects under section 732(d), see Sec. 1.734-2.

    (c) Allocation of basis. For allocation among the partnership 
properties of basis adjustments under section 734(b) and paragraph (b) 
of this section, see section 755 and Sec. 1.755-1.
    (d) Returns. A partnership which must adjust the bases of 
partnership properties under section 734 shall attach a statement to the 
partnership return for the year of the distribution setting forth the 
computation of the adjustment and the partnership properties to which 
the adjustment has been allocated.



Sec. 1.734-2   Adjustment after distribution to transferee partner.

    (a) In the case of a distribution of property by the partnership to 
a partner who has obtained all or part of his partnership interest by 
transfer, the adjustments to basis provided in section 743(b) and 
section 732(d) shall be taken into account in applying the rules under 
section 734(b). For determining the adjusted basis of distributed 
property to the partnership immediately before the distribution where 
there has been a prior transfer of a partnership interest with respect 
to which the election provided in section 754 or section 732(d) is in 
effect, see Secs. 1.732-1 and 1.732-2.
    (b)(1) If a transferee partner, in liquidation of his entire 
partnership interest, receives a distribution of property (including 
money) with respect to

[[Page 439]]

which he has no special basis adjustment, in exchange for his interest 
in property with respect to which he has a special basis adjustment, and 
does not utilize his entire special basis adjustment in determining the 
basis of the distributed property to him under section 732, the unused 
special basis adjustment of the distributee shall be applied as an 
adjustment to the partnership basis of the property retained by the 
partnership and as to which the distributee did not use his special 
basis adjustment. The provisions of this subparagraph may be illustrated 
by the following example:

    Example. Upon the death of his father, partner S acquires by 
inheritance a half-interest in partnership ACS. Partners A and C each 
have a one-quarter interest. The assets of the partnership consist of 
$10,000 cash and land used in farming worth $10,000 with a basis of 
$1,000 to the partnership. Since the partnership had made the election 
under section 754 at the time of transfer, partner S had a special basis 
adjustment of $4,500 under section 743(b) with respect to his undivided 
half-interest in the real estate. The basis of S's partnership interest, 
in accordance with section 742, is $10,000. S retires from the 
partnership and receives $10,000 in cash in exchange for his entire 
interest. Since S has received no part of the real estate, his special 
basis adjustment of $4,500 will be allocated to the real estate, the 
remaining partnership property, and will increase its basis to the 
partnership to $5,500.

    (2) The provisions of this paragraph do not apply to the extent that 
certain distributions are treated as sales or exchanges under section 
751(b) (relating to unrealized receivables and substantially appreciated 
inventory items). See section 751(b) and paragraph (b) of Sec. 1.751-1.



Sec. 1.735-1   Character of gain or loss on disposition of distributed property.

    (a) Sale or exchange of distributed property--(1) Unrealized 
receivables. Any gain realized or loss sustained by a partner on a sale 
or exchange or other disposition of unrealized receivables (as defined 
in paragraph (c)(1) of Sec. 1.751-1) received by him in a distribution 
from a partnership shall be considered gain or loss from the sale or 
exchange of property other than a capital asset.
    (2) Inventory items. Any gain realized or loss sustained by a 
partner on a sale or exchange of inventory items (as defined in section 
751(d)(2)) received in a distribution from a partnership shall be 
considered gain or loss from the sale or exchange of property other than 
a capital asset if such inventory items are sold or exchanged within 5 
years from the date of the distribution by the partnership. The 
character of any gain or loss from a sale or exchange by the distributee 
partner of such inventory items after 5 years from the date of 
distribution shall be determined as of the date of such sale or exchange 
by reference to the character of the assets in his hands at that date 
(inventory items, capital assets, property used in a trade or business, 
etc.).
    (b) Holding period for distributed property. A partner's holding 
period for property distributed to him by a partnership shall include 
the period such property was held by the partnership. The provisions of 
this paragraph do not apply for the purpose of determining the 5-year 
period described in section 735(a)(2) and paragraph (a)(2) of this 
section. If the property has been contributed to the partnership by a 
partner, then the period that the property was held by such partner 
shall also be included. See section 1223(2). For a partnership's holding 
period for contributed property, see Sec. 1.723-1.
    (c) Effective date. Section 735(a) applies to any property 
distributed by a partnership to a partner after March 9, 1954. See 
section 771(b)(2) and paragraph (b)(2) of Sec. 1.771-1. However, see 
section 771(c).

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8574, July 7, 1965]



Sec. 1.736-1   Payments to a retiring partner or a deceased partner's successor in interest.

    (a) Payments considered as distributive share or guaranteed payment. 
(1)(i) Section 736 and this section apply only to payments made to a 
retiring partner or to a deceased partner's successor in interest in 
liquidation of such partner's entire interest in the partnership. See 
section 761(d). Section 736 and this section do not apply if the estate 
or other successor in interest of a deceased partner continues as a 
partner in its own right under local law. Section 736

[[Page 440]]

and this section apply only to payments made by the partnership and not 
to transactions between the partners. Thus, a sale by partner A to 
partner B of his entire one-fourth interest in partnership ABCD would 
not come within the scope of section 736.
    (ii) A partner retires when he ceases to be a partner under local 
law. However, for the purposes of subchapter K, chapter 1 of the Code, a 
retired partner or a deceased partner's successor will be treated as a 
partner until his interest in the partnership has been completely 
liquidated.
    (2) When payments (including assumption of liabilities treated as a 
distribution of money under section 752) are made to a withdrawing 
partner, that is, a retiring partner or the estate or other successor in 
interest of a deceased partner, the amounts paid may represent several 
items. In part, they may represent the fair market value at the time of 
his death or retirement of the withdrawing partner's interest in all the 
assets of the partnership (including inventory) unreduced by partnership 
liabilities. Also, part of such payments may be attributable to his 
interest in unrealized receivables and part to an arrangement among the 
partners in the nature of mutual insurance. When a partnership makes 
such payments, whether or not related to partnership income, to retire 
the withdrawing partner's entire interest in the partnership, the 
payments must be allocated between (i) payments for the value of his 
interest in assets, except unrealized receivables and, under some 
circumstances, good will (section 736(b)), and (ii) other payments 
(section 736(a)). The amounts paid for his interest in assets are 
treated in the same manner as a distribution in complete liquidation 
under sections 731, 732, and, where applicable, 751. See paragraph 
(b)(4)(ii) of Sec. 1.751-1. The remaining partners are allowed no 
deduction for these payments since they represent either a distribution 
or a purchase of the withdrawing partner's capital interest by the 
partnership (composed of the remaining partners).
    (3) Under section 736(a), the portion of the payments made to a 
withdrawing partner for his share of unrealized receivables, good will 
(in the absence of an agreement to the contrary), or otherwise not in 
exchange for his interest in assets under the rules contained in 
paragraph (b) of this section will be considered either:
    (i) A distributive share of partnership income, if the amount of 
payment is determined with regard to income of the partnership; or
    (ii) A guaranteed payment under section 707(c), if the amount of the 
payment is determined without regard to income of the partnership.
    (4) Payments, to the extent considered as a distributive share of 
partnership income under section 736(a)(1), are taken into account under 
section 702 in the income of the withdrawing partner and thus reduce the 
amount of the distributive shares of the remaining partners. Payments, 
to the extent considered as guaranteed payments under section 736(a)(2), 
are deductible by the partnership under section 162(a) and are taxable 
as ordinary income to the recipient under section 61(a). See section 
707(c).
    (5) The amount of any payments under section 736(a) shall be 
included in the income of the recipient for his taxable year with or 
within which ends the partnership taxable year for which the payment is 
a distributive share, or in which the partnership is entitled to deduct 
such amount as a guaranteed payment. On the other hand, payments under 
section 736(b) shall be taken into account by the recipient for his 
taxable year in which such payments are made. See paragraph (b)(4) of 
this section.
    (6) A retiring partner or a deceased partner's successor in interest 
receiving payments under section 736 is regarded as a partner until the 
entire interest of the retiring or deceased partner is liquidated. 
Therefore, if one of the members of a 2-man partnership retires under a 
plan whereby he is to receive payments under section 736, the 
partnership will not be considered terminated, nor will the partnership 
year close with respect to either partner, until the retiring partner's 
entire interest is liquidated, since the retiring partner continues to 
hold a partnership interest in the partnership until that time. 
Similarly, if a partner in a 2-man partnership dies, and his estate or 
other successor in interest receives

[[Page 441]]

payments under section 736, the partnership shall not be considered to 
have terminated upon the death of the partner but shall terminate as to 
both partners only when the entire interest of the decedent is 
liquidated. See section 708(b).
    (b) Payments for interest in partnership. (1) Payments made in 
liquidation of the entire interest of a retiring partner or deceased 
partner shall, to the extent made in exchange for such partner's 
interest in partnership property (except for unrealized receivables and 
good will as provided in subparagraphs (2) and (3) of this paragraph), 
be considered as a distribution by the partnership (and not as a 
distributive share or guaranteed payment under section 736(a)). 
Generally, the valuation placed by the partners upon a partner's 
interest in partnership property in an arm's length agreement will be 
regarded as correct. If such valuation reflects only the partner's net 
interest in the property (i.e., total assets less liabilities), it must 
be adjusted so that both the value of the partner's interest in property 
and the basis for his interest take into account the partner's share of 
partnership liabilities. Gain or loss with respect to distributions 
under section 736(b) and this paragraph will be recognized to the 
distributee to the extent provided in section 731 and, where applicable, 
section 751.
    (2) Payments made to a retiring partner or to the successor in 
interest of a deceased partner for his interest in unrealized 
receivables of the partnership in excess of their partnership basis, 
including any special basis adjustment for them to which such partner is 
entitled, shall not be considered as made in exchange for such partner's 
interest in partnership property. Such payments shall be treated as 
payments under section 736(a) and paragraph (a) of this section. For 
definition of unrealized receivables, see section 751(c).
    (3) For the purposes of section 736(b) and this paragraph, payments 
made to a retiring partner or to a successor in interest of a deceased 
partner in exchange for the interest of such partner in partnership 
property shall not include any amount paid for the partner's share of 
good will of the partnership in excess of its partnership basis, 
including any special basis adjustments for it to which such partner is 
entitled, except to the extent that the partnership agreement provides 
for a reasonable payment with respect to such good will. Such payments 
shall be considered as payments under section 736(a). To the extent that 
the partnership agreement provides for a reasonable payment with respect 
to good will, such payments shall be treated under section 736(b) and 
this paragraph. Generally, the valuation placed upon good will by an 
arm's length agreement of the partners, whether specific in amount or 
determined by a formula, shall be regarded as correct.
    (4) Payments made to a retiring partner or to a successor in 
interest of a deceased partner for his interest in inventory shall be 
considered as made in exchange for such partner's interest in 
partnership property for the purposes of section 736(b) and this 
paragraph. However, payments for an interest in substantially 
appreciated inventory items, as defined in section 751(d), are subject 
to the rules provided in section 751(b) and paragraph (b) of Sec. 1.751-
1. The partnership basis in inventory items as to a deceased partner's 
successor in interest does not change because of the death of the 
partner unless the partnership has elected the optional basis adjustment 
under section 754. But see paragraph (b)(3)(iii) of Sec. 1.751-1.
    (5) Where payments made under section 736 are received during the 
taxable year, the recipient must segregate that portion of each such 
payment which is determined to be in exchange for the partner's interest 
in partnership property and treated as a distribution under section 
736(b) from that portion treated as a distributive share or guaranteed 
payment under section 736(a). Such allocation shall be made as follows:
    (i) If a fixed amount (whether or not supplemented by any additional 
amounts) is to be received over a fixed number of years, the portion of 
each payment to be treated as a distribution under section 736(b) for 
the taxable year shall bear the same ratio to the total fixed agreed 
payments for such year (as distinguished from the amount actually 
received) as the total fixed agreed payments under section 736(b)

[[Page 442]]

bear to the total fixed agreed payments under section 736 (a) and (b). 
The balance, if any, of such amount received in the same taxable year 
shall be treated as a distributive share or a guaranteed payment under 
section 736(a) (1) or (2). However, if the total amount received in any 
one year is less than the amount considered as a distribution under 
section 736(b) for that year, then any unapplied portion shall be added 
to the portion of the payments for the following year or years which are 
to be treated as a distribution under section 736(b). For example, 
retiring partner W who is entitled to an annual payment of $6,000 for 10 
years for his interest in partnership property, receives only $3,500 in 
1955. In 1956, he receives $10,000. Of this amount, $8,500 ($6,000 plus 
$2,500 from 1955) is treated as a distribution under section 736 (b) for 
1956; $1,500, as a payment under section 736(a).
    (ii) If the retiring partner or deceased partner's successor in 
interest receives payments which are not fixed in amount, such payments 
shall first be treated as payments in exchange for his interest in 
partnership property under section 736(b) to the extent of the value of 
that interest and, thereafter, as payments under section 736(a).
    (iii) In lieu of the rules provided in subdivisions (i) and (ii) of 
this subparagraph, the allocation of each annual payment between section 
736 (a) and (b) may be made in any manner to which all the remaining 
partners and the withdrawing partner or his successor in interest agree, 
provided that the total amount allocated to property under section 
736(b) does not exceed the fair market value of such property at the 
date of death or retirement.
    (6) Except to the extent section 751(b) applies, the amount of any 
gain or loss with respect to payments under section 736(b) for a 
retiring or deceased partner's interest in property for each year of 
payment shall be determined under section 731. However, where the total 
of section 736(b) payments is a fixed sum, a retiring partner or a 
deceased partner's successor in interest may elect (in his tax return 
for the first taxable year for which he receives such payments), to 
report and to measure the amount of any gain or loss by the difference 
between:
    (i) The amount treated as a distribution under section 736(b) in 
that year, and
    (ii) The portion of the adjusted basis of the partner for his 
partnership interest attributable to such distribution (i.e., the amount 
which bears the same proportion to the partner's total adjusted basis 
for his partnership interest as the amount distributed under section 
736(b) in that year bears to the total amount to be distributed under 
section 736(b)).

A recipient who elects under this subparagraph shall attach a statement 
to his tax return for the first taxable year for which he receives such 
payments, indicating his election and showing the computation of the 
gain included in gross income.
    (7) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. Partnership ABC is a personal service partnership and its 
balance sheet is as follows:

                                 Assets                                 
------------------------------------------------------------------------
                                                     Adjusted           
                                                    basis per    Market 
                                                      books      value  
------------------------------------------------------------------------
Cash..............................................    $13,000    $13,000
Unrealized receivables............................          0     30,000
Capital and section 1231 assets...................     20,000     23,000
                                                   ---------------------
    Total.........................................     33,000     66,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                    Per books    Value  
------------------------------------------------------------------------
Liabilities.......................................     $3,000     $3,000
Capital:                                                                
  A...............................................     10,000     21,000
  B...............................................     10,000     21,000
  C...............................................     10,000     21,000
                                                   ---------------------
    Total.........................................     33,000     66,000
------------------------------------------------------------------------


[[Page 443]]

Partner A retires from the partnership in accordance with an agreement 
whereby his share of liabilities ($1,000) is assumed. In addition he is 
to receive $9,000 in the year of retirement plus $10,000 in each of the 
two succeeding years. Thus, the total that A receives for his 
partnership interest is $30,000 ($29,000 in cash and $1,000 in 
liabilities assumed). Under the agreement terminating A's interest, the 
value of A's interest in section 736(b) partnership property is $12,000 
(one-third of $36,000, the sum of $13,000 cash and $23,000, the fair 
market value of capital and section 1231 assets). A's share in 
unrealized receivables is not included in his interest in partnership 
property described in section 736(b). Since the basis of A's interest is 
$11,000 ($10,000 plus $1,000, his share of partnership liabilities), he 
will realize a capital gain of $1,000 ($12,000 minus $11,000) from the 
disposition of his interest in partnership property. The remaining 
$18,000 ($30,000 minus $12,000) will constitute payments under section 
736(a)(2) which are taxable to A as guaranteed payments under section 
707(c). The payment for the first year is $10,000, consisting of $9,000 
in cash, plus $1,000 in liability assumed (section 752(b)). Thus, unless 
the partners agree otherwise under subparagraph (5)(iii) of this 
paragraph, each annual payment of $10,000 will be allocated as follows: 
$6,000 (18,000/30,000 of $10,000) is a section 736(a)(2) payment and 
$4,000 (12,000/30,000 of $10,000) is a payment for an interest in 
section 736(b) partnership property. (The partnership may deduct the 
$6,000 guaranteed payment made to A in each of the 3 years.) The gain on 
the payments for partnership property will be determined under section 
731, as provided in subparagraph (6) of this paragraph. A will treat 
only $4,000 of each payment as a distribution in a series in liquidation 
of his entire interest and, under section 731, will have a capital gain 
of $1,000 when the last payment is made. However, if A so elects, as 
provided in subparagraph (6) of this paragraph, he may treat such gain 
as follows: Of each $4,000 payment attributable to A's interest in 
partnership property, $333 is capital gain (one-third of the total 
capital gain of $1,000), and $3,667 is a return of capital.
    Example 2. Assume the same facts as in example 1 of this 
subparagraph except that the agreement between the partners provides for 
payments to A for 3 years of a percentage of annual income instead of a 
fixed amount. Unless the partners agree otherwise under subparagraph 
(5)(iii) of this paragraph, all payments received by A up to $12,000 
shall be treated under section 736(b) as payments for A's interest in 
partnership property. His gain of $1,000 will be taxed only after he has 
received his full basis under section 731. Since the payments are not 
fixed in amount, the election provided in subparagraph (6) of this 
paragraph is not available. Any payments in excess of $12,000 shall be 
treated as a distributive share of partnership income to A under section 
736(a)(1).
    Example 3. Assume the same facts as in example 1 of this 
subparagraph except that the partnership agreement provides that the 
payment for A's interest in partnership property shall include payment 
for his interest in the good will of the partnership. At the time of A's 
retirement, the partners determine the value of partnership good will to 
be $9,000. The value of A's interest in partnership property described 
in section 736(b) is thus $15,000 (one-third of $45,000, the sum of 
$13,000 cash, plus $23,000, the value of capital and section 1231 
assets, plus $9,000 good will). From the disposition of his interest in 
partnership property, A will realize a capital gain of $4,000 ($15,000, 
minus $11,000) the basis of his interest. The remaining $15,000 ($30,000 
minus $15,000) will constitute payments under section 736(a)(2) which 
are taxable to A as guaranteed payments under section 707(c).
    Example 4. Assume the same facts as in example 1 of this 
subparagraph except that the capital and section 1231 assets consist of 
an item of section 1245 property (as defined in section 1245(a)(3)). 
Assume further that under paragraph (c)(4) of Sec. 1.751-1 the section 
1245 property is an unrealized receivable to the extent of $2,000. 
Therefore, the value of A's interest in section 736(b) partnership 
property is only $11,333 (one-third of $34,000, the sum of $13,000 cash 
and $21,000, the fair market value of section 1245 property to the 
extent not an unrealized receivable). From the disposition of his 
interest in partnership property, A will realize a capital gain of $333 
($11,333 minus $11,000, the basis of his interest). The remaining 
$18,667 ($30,000 minus $11,333) will constitute payments under section 
736(a)(2) which are taxable to A as guaranteed payments under section 
707(c).

    (c) Cross reference. See section 753 for treatment of payments under 
section 736(a) as income in respect of a decedent under section 691.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8574, July 7, 1965]



Sec. 1.737-1  Recognition of precontribution gain.

    (a) Determination of gain--(1) In general. A partner that receives a 
distribution of property (other than money) must recognize gain under 
section 737 and this section in an amount equal to the lesser of the 
excess distribution (as defined in paragraph (b) of this section) or the 
partner's net precontribution gain (as defined in paragraph (c) of this 
section). Gain recognized under section

[[Page 444]]

737 and this section is in addition to any gain recognized under section 
731.
    (2) Transactions to which section 737 applies. Section 737 and this 
section apply only to the extent that a distribution by a partnership is 
a distribution to a partner acting in the capacity of a partner within 
the meaning of section 731, except that section 737 and this section do 
not apply to the extent that section 751(b) applies to the distribution.
    (b) Excess distribution--(1) Definition. The excess distribution is 
the amount (if any) by which the fair market value of the distributed 
property (other than money) exceeds the distributee partner's adjusted 
tax basis in the partner's partnership interest.
    (2) Fair market value of property. The fair market value of the 
distributed property is the price at which the property would change 
hands between a willing buyer and a willing seller at the time of the 
distribution, neither being under any compulsion to buy or sell and both 
having reasonable knowledge of the relevant facts. The fair market value 
that a partnership assigns to distributed property will be regarded as 
correct, provided that the value is reasonably agreed to among the 
partners in an arm's-length negotiation and the partners have 
sufficiently adverse interests.
    (3) Distributee partner's adjusted tax basis--(i) General rule. In 
determining the amount of the excess distribution, the distributee 
partner's adjusted tax basis in the partnership interest includes any 
basis adjustment resulting from the distribution that is subject to 
section 737 (for example, adjustments required under section 752) and 
from any other distribution or transaction that is part of the same 
distribution, except for--
    (A) The increase required under section 737(c)(1) for the gain 
recognized by the partner under section 737; and
    (B) The decrease required under section 733(2) for any property 
distributed to the partner other than property previously contributed to 
the partnership by the distributee partner. See Sec. 1.704-4(e)(1) for a 
rule in the context of section 704(c)(1)(B). See also Sec. 1.737-3(b)(2) 
for a special rule for determining a partner's adjusted tax basis in 
distributed property previously contributed by the partner to the 
partnership.
    (ii) Advances or drawings. The distributee partner's adjusted tax 
basis in the partnership interest is determined as of the last day of 
the partnership's taxable year if the distribution to which section 737 
applies is properly characterized as an advance or drawing against the 
partner's distributive share of income. See Sec. 1.731-1(a)(1)(ii).
    (c) Net precontribution gain--(1) General rule. The distributee 
partner's net precontribution gain is the net gain (if any) that would 
have been recognized by the distributee partner under section 
704(c)(1)(B) and Sec. 1.704-4 if all property that had been contributed 
to the partnership by the distributee partner within five years of the 
distribution and is held by the partnership immediately before the 
distribution had been distributed by the partnership to another partner 
other than a partner who owns, directly or indirectly, more than 50 
percent of the capital or profits interest in the partnership. See 
Sec. 1.704-4 for provisions determining a contributing partner's gain or 
loss under section 704(c)(1)(B) on an actual distribution of contributed 
section 704(c) property to another partner.
    (2) Special rules--(i) Property contributed on or before October 3, 
1989. Property contributed to the partnership on or before October 3, 
1989, is not taken into account in determining a partner's net 
precontribution gain. See Sec. 1.704-4(c)(1) for a similar rule in the 
context of section 704(c)(1)(B).
    (ii) Section 734(b)(1)(A) adjustments. For distributions to a 
distributee partner of money by a partnership with a section 754 
election in effect that are part of the same distribution as the 
distribution of property subject to section 737, for purposes of 
paragraph (a) and (c)(1) of this section the distributee partner's net 
precontribution gain is reduced by the basis adjustments (if any) made 
to section 704(c) property contributed by the distributee partner under 
section 734(b)(1)(A). See Sec. 1.737-3(c)(4) for rules regarding basis 
adjustments for partnerships with a section 754 election in effect.
    (iii) Transfers of a partnership interest. The transferee of all or 
a portion of a

[[Page 445]]

contributing partner's partnership interest succeeds to the transferor's 
net precontribution gain, if any, in an amount proportionate to the 
interest transferred. See Sec. 1.704-3(a)(7) and Sec. 1.704-4(d)(2) for 
similar provisions in the context of section 704(c)(1)(A) and section 
704(c)(1)(B).
    (iv) Section 704(c)(1)(B) gain recognized in related distribution. A 
distributee partner's net precontribution gain is determined after 
taking into account any gain or loss recognized by the partner under 
section 704(c)(1)(B) and Sec. 1.704-4 (or that would have been 
recognized by the partner except for the like-kind exception in section 
704(c)(2) and Sec. 1.704-4(d)(3)) on an actual distribution to another 
partner of section 704(c) property contributed by the distributee 
partner that is part of the same distribution as the distribution to the 
distributee partner.
    (v) Section 704(c)(2) disregarded. A distributee partner's net 
precontribution gain is determined without regard to the provisions of 
section 704(c)(2) and Sec. 1.704-4(d)(3) in situations in which the 
property contributed by the distributee partner is not actually 
distributed to another partner in a distribution related to the section 
737 distribution.
    (d) Character of gain. The character of the gain recognized by the 
distributee partner under section 737 and this section is determined by, 
and is proportionate to, the character of the partner's net 
precontribution gain. For this purpose, all gains and losses on section 
704(c) property taken into account in determining the partner's net 
precontribution gain are netted according to their character. Character 
is determined at the partnership level for this purpose, and any 
character with a net negative amount is disregarded. The character of 
the partner's gain under section 737 is the same as, and in proportion 
to, any character with a net positive amount. Character for this purpose 
is determined as if the section 704(c) property had been sold by the 
partnership to an unrelated third party at the time of the distribution 
and includes any item that would have been taken into account separately 
by the contributing partner under section 702(a) and Sec. 1.702-1(a).
    (e) Examples. The following examples illustrate the provisions of 
this section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 737, and all partners are unrelated.

    Example 1. Calculation of excess distribution and net 
precontribution gain. (i) On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes Property A, depreciable 
real property with a fair market value of $30,000 and an adjusted tax 
basis of $20,000. B contributes Property B, nondepreciable real property 
with a fair market value and adjusted tax basis of $30,000. C 
contributes $30,000 cash.
    (ii) Property A has 10 years remaining on its cost recovery schedule 
and is depreciated using the straight-line method. The partnership uses 
the traditional method for allocating items under section 704(c) 
described in Sec. 1.704-3(b)(1) for Property A. The partnership has book 
depreciation of $3,000 per year (10 percent of the $30,000 book basis in 
Property A) and each partner is allocated $1,000 of book depreciation 
per year (one-third of the total annual book depreciation of $3,000). 
The partnership also has tax depreciation of $2,000 per year (10 percent 
of the $20,000 adjusted tax basis in Property A). This $2,000 tax 
depreciation is allocated equally between B and C, the noncontributing 
partners with respect to Property A.
    (iii) At the end of 1997, the book value of Property A is $21,000 
($30,000 initial book value less $9,000 aggregate book depreciation) and 
its adjusted tax basis is $14,000 ($20,000 initial tax basis less $6,000 
aggregate tax depreciation).
    (iv) On December 31, 1997, Property B is distributed to A in 
complete liquidation of A's partnership interest. The adjusted tax basis 
of A's partnership interest at that time is $20,000. The amount of the 
excess distribution is $10,000, the difference between the fair market 
value of the distributed Property B ($30,000) and A's adjusted tax basis 
in A's partnership interest ($20,000). A's net precontribution gain is 
$7,000, the difference between the book value of Property A ($21,000) 
and its adjusted tax basis at the time of the distribution ($14,000). A 
recognizes gain of $7,000 on the distribution, the lesser of the excess 
distribution and the net precontribution gain.
    Example 2. Determination of distributee partner's basis. (i) On 
January 1, 1995, A, B, and C form general partnership ABC as equal 
partners. A contributes Property A, nondepreciable real property with a 
fair market value

[[Page 446]]

of $10,000 and an adjusted tax basis of $4,000. B and C each contributes 
$10,000 cash.
    (ii) The partnership purchases Property B, nondepreciable real 
property with a fair market value of $9,000, subject to a $9,000 
nonrecourse liability. This nonrecourse liability is allocated equally 
among the partners under section 752, increasing A's adjusted tax basis 
in A's partnership interest from $4,000 to $7,000.
    (iii) On December 31, 1998, A receives $2,000 cash and Property B, 
subject to the $9,000 liability, in a current distribution.
    (iv) In determining the amount of the excess distribution, the 
adjusted tax basis of A's partnership interest is adjusted to take into 
account the distribution of money and the shift in liabilities. A's 
adjusted tax basis is therefore increased to $11,000 for this purpose 
($7,000 initial adjusted tax basis, less $2,000 distribution of money, 
less $3,000 (decrease in A's share of the $9,000 partnership liability), 
plus $9,000 (increase in A's individual liabilities)). As a result of 
this basis adjustment, the adjusted tax basis of A's partnership 
interest ($11,000) is greater than the fair market value of the 
distributed property ($9,000) and therefore, there is no excess 
distribution. A recognizes no gain under section 737.
    Example 3. Net precontribution gain reduced for gain recognized 
under section 704(c)(1)(B). (i) On January 1, 1995, A, B, and C form 
partnership ABC as equal partners. A contributes Properties A1 and A2, 
nondepreciable real properties located in the United States each with a 
fair market value of $10,000 and an adjusted tax basis of $6,000. B 
contributes Property B, nondepreciable real property located outside the 
United States, with a fair market value and adjusted tax basis of 
$20,000. C contributes $20,000 cash.
    (ii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest and, as part of the same 
distribution, Property A1 is distributed to B in a current distribution.
    (iii) A's net precontribution gain before the distribution is $8,000 
($20,000 fair market value of Properties A1 and A2 less $12,000 adjusted 
tax basis of such properties). A recognizes $4,000 of gain under section 
704(c)(1)(B) and Sec. 1.704-4 on the distribution of Property A1 to B 
($10,000 fair market value of Property A1 less $6,000 adjusted tax basis 
of Property A1). This gain is taken into account in determining A's 
excess distribution and net precontribution gain. As a result, A's net 
precontribution gain is reduced from $8,000 to $4,000, and the adjusted 
tax basis in A's partnership interest is increased by $4,000 to $16,000.
    (iv) A recognizes gain of $4,000 on the receipt of Property B under 
section 737, an amount equal to the lesser of the excess distribution of 
$4,000 ($20,000 fair market value of Property B less $16,000 adjusted 
tax basis of A's interest in the partnership) and A's remaining net 
precontribution gain of $4,000.
    Example 4. Character of gain. (i) On January 1, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes the following 
nondepreciable property to the partnership:

------------------------------------------------------------------------
                                                       Fair             
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $30,000    $20,000
Property A2.......................................     30,000     38,000
Property A3.......................................     10,000      9,000
------------------------------------------------------------------------

    (ii) The character of gain or loss on Property A1 and Property A2 is 
long-term, U.S.-source capital gain or loss. The character of gain on 
Property A3 is long-term, foreign-source capital gain. B contributes 
Property B, nondepreciable real property with a fair market value and 
adjusted tax basis of $70,000. C contributes $70,000 cash.
    (iii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
$3,000 of gain under section 737, an amount equal to the excess 
distribution of $3,000 ($70,000 fair market value of Property B less 
$67,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $3,000 ($70,000 aggregate fair market value of 
properties contributed by A less $67,000 aggregate adjusted tax basis of 
such properties).
    (iv) In determining the character of A's gain, all gains and losses 
on property taken into account in determining A's net precontribution 
gain are netted according to their character and allocated to A's 
recognized gain under section 737 based on the relative proportions of 
the net positive amounts. U.S.-source and foreign-source gains must be 
netted separately because A would have been required to take such gains 
into account separately under section 702. As a result, A's net 
precontribution gain of $3,000 consists of $2,000 of net long-term, 
U.S.-source capital gain ($10,000 gain on Property A1 and $8,000 loss on 
Property A2) and $1,000 of net long-term, foreign-source capital gain 
($1,000 gain on Property A3).
    (v) The character of A's gain under paragraph (d) of this section is 
therefore $2,000 long-term, U.S.-source capital gain ($3,000 gain 
recognized under section 737  x  $2,000 net long-term, U.S.-source 
capital gain/$3,000 total net precontribution gain) and $1,000 long-
term, foreign-source capital gain ($3,000 gain recognized under section 
737  x  $1,000 net long-term, foreign-source capital gain/$3,000 total 
net precontribution gain).

[T.D. 8642, 60 FR 66733, Dec. 26, 1995]



Sec. 1.737-2  Exceptions and special rules.

    (a) Section 708(b)(1)(B) terminations. Section 737 and this section 
do not

[[Page 447]]

apply to a deemed distribution of property caused by a termination of 
the partnership under section 708(b)(1)(B). See Sec. 1.704-4(c)(3) for a 
similar rule in the context of section 704(c)(1)(B).
    (b) Transfers to another partnership--(1) Complete transfer. Section 
737 and this section do not apply to a transfer by a partnership 
(transferor partnership) of all of its assets and liabilities to a 
second partnership (transferee partnership) in an exchange described in 
section 721, followed by a distribution of the interest in the 
transferee partnership in liquidation of the transferor partnership as 
part of the same plan or arrangement. See Sec. 1.704-4(c)(4) for a 
similar rule in the context of section 704(c)(1)(B).
    (2) Certain divisive transactions. Section 737 and this section do 
not apply to a transfer by a partnership (transferor partnership) of all 
of the section 704(c) property contributed by a partner to a second 
partnership (transferee partnership) in an exchange described in section 
721, followed by a distribution as part of the same plan or arrangement 
of an interest in the transferee partnership (and no other property) in 
complete liquidation of the interest of the partner that originally 
contributed the section 704(c) property to the transferor partnership.
    (3) Subsequent distributions. A subsequent distribution of property 
by the transferee partnership to a partner of the transferee partnership 
that was formerly a partner of the transferor partnership is subject to 
section 737 to the same extent that a distribution from the transferor 
partnership would have been subject to section 737.
    (c) Incorporation of a partnership. Section 737 and this section do 
not apply to an incorporation of a partnership by any method of 
incorporation (other than a method involving an actual distribution of 
partnership property to the partners followed by a contribution of that 
property to a corporation), provided that the partnership is liquidated 
as part of the incorporation transaction. See Sec. 1.704-4(c)(5) for a 
similar rule in the context of section 704(c)(1)(B).
    (d) Distribution of previously contributed property--(1) General 
rule. Any portion of the distributed property that consists of property 
previously contributed by the distributee partner (including property 
treated as contributed by the partner in connection with a termination 
of the partnership under section 708(b)(1)(B)) (previously contributed 
property) is not taken into account in determining the amount of the 
excess distribution or the partner's net precontribution gain. See 
Sec. 1.737-3(b)(2) for a special rule for determining the basis of 
previously contributed property in the hands of a distributee partner 
who contributed the property to the partnership.
    (2) Limitation for distribution of previously contributed interest 
in an entity. An interest in an entity previously contributed to the 
partnership is not treated as previously contributed property to the 
extent that the value of the interest is attributable to property 
contributed to the entity after the interest was contributed to the 
partnership. The preceding sentence does not apply to the extent that 
the property contributed to the entity was contributed to the 
partnership by the partner that also contributed the interest in the 
entity to the partnership.
    (3) Nonrecognition transactions. Property received by the 
partnership in exchange for contributed section 704(c) property in a 
nonrecognition transaction is treated as the contributed property with 
regard to the contributing partner for purposes of section 737 to the 
extent that the property received is treated as section 704(c) property 
under Sec. 1.704-3(a)(8). See Sec. 1.704-4(d)(1) for a similar rule in 
the context of section 704(c)(1)(B).
    (4) Undivided interests. The distribution of an undivided interest 
in property is treated as the distribution of previously contributed 
property to the extent that the undivided interest does not exceed the 
undivided interest, if any, contributed by the distributee partner in 
the same property. See Sec. 1.704-4(c)(6) for the application of section 
704(c)(1)(B) in a similar context. The portion of the undivided interest 
in property retained by the partnership after the distribution, if any, 
that is treated as contributed by the distributee partner, is reduced to 
the extent of the undivided interest distributed to the distributee 
partner.

[[Page 448]]

    (e) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 737, and all partners are unrelated.

    Example 1. Distribution of previously contributed property. (i) On 
January 1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes the following nondepreciable real property to the 
partnership:

------------------------------------------------------------------------
                                                       Fair             
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $20,000    $10,000
Property A2.......................................     10,000      6,000
------------------------------------------------------------------------

    (ii) A's total net precontribution gain on the contributed property 
is $14,000 ($10,000 on Property A1 plus $4,000 on Property A2). B 
contributes $10,000 cash and Property B, nondepreciable real property 
with a fair market value and adjusted tax basis of $20,000. C 
contributes $30,000 cash.
    (iii) On December 31, 1998, Property A2 and Property B are 
distributed to A in complete liquidation of A's interest in the 
partnership. Property A2 was previously contributed by A and is 
therefore not taken into account in determining the amount of the excess 
distribution or A's net precontribution gain. The adjusted tax basis of 
Property A2 in the hands of A is also determined under section 732 as if 
that property were the only property distributed to A.
    (iv) As a result of excluding Property A2 from these determinations, 
the amount of the excess distribution is $10,000 ($20,000 fair market 
value of distributed Property B less $10,000 adjusted tax basis in A's 
partnership interest). A's net precontribution gain is also $10,000 
($14,000 total net precontribution gain less $4,000 gain with respect to 
previously contributed Property A2). A therefore recognizes $10,000 of 
gain on the distribution, the lesser of the excess distribution and the 
net precontribution gain.
    Example 2. Distribution of a previously contributed interest in an 
entity. (i) On January 1, 1995, A, B, and C form partnership ABC as 
equal partners. A contributes Property A, nondepreciable real property 
with a fair market value of $10,000 and an adjusted tax basis of $5,000, 
and all of the stock of Corporation X with a fair market value and 
adjusted tax basis of $500. B contributes $500 cash and Property B, 
nondepreciable real property with a fair market value and adjusted tax 
basis of $10,000. Partner C contributes $10,500 cash. On December 31, 
1996, ABC contributes Property B to Corporation X in a nonrecognition 
transaction under section 351.
    (ii) On December 31, 1998, all of the stock of Corporation X is 
distributed to A in complete liquidation of A's interest in the 
partnership. The stock is treated as previously contributed property 
with respect to A only to the extent of the $500 fair market value of 
the Corporation X stock contributed by A. The fair market value of the 
distributed stock for purposes of determining the amount of the excess 
distribution is therefore $10,000 ($10,500 total fair market value of 
Corporation X stock less $500 portion treated as previously contributed 
property). The $500 fair market value and adjusted tax basis of the 
Corporation X stock is also not taken into account in determining the 
amount of the excess distribution and the net precontribution gain.
    (iii) A recognizes $5,000 of gain under section 737, the amount of 
the excess distribution ($10,000 fair market value of distributed 
property less $5,000 adjusted tax basis in A's partnership interest) and 
A's net precontribution gain ($10,000 fair market value of Property A 
less $5,000 adjusted tax basis in Property A).
    Example 3. Distribution of undivided interest in property. (i) On 
January 1, 1995, A and B form partnership AB as equal partners. A 
contributes $500 cash and an undivided one-half interest in Property X. 
B contributes $500 cash and an undivided one-half interest in Property 
X.
    (ii) On December 31, 1998, an undivided one-half interest in 
Property X is distributed to A in a current distribution. The 
distribution of the undivided one-half interest in Property X is treated 
as a distribution of previously contributed property because A 
contributed an undivided one-half interest in Property X. As a result, A 
does not recognize any gain under section 737 on the distribution.
[T.D. 8642, 60 FR 66735, Dec. 26, 1995]



Sec. 1.737-3  Basis adjustments; Recovery rules.

    (a) Distributee partner's adjusted tax basis in the partnership 
interest. The distributee partner's adjusted tax basis in the 
partnership interest is increased by the amount of gain recognized by 
the distributee partner under section 737 and this section. This 
increase is not taken into account in determining the amount of gain 
recognized by the partner under section 737(a)(1) and this section or in 
determining the amount of gain recognized by the partner under section 
731(a) on the distribution of money in the same distribution or any 
related distribution. See Sec. 1.704-4(e)(1)

[[Page 449]]

for a determination of the distributee partner's adjusted tax basis in a 
distribution subject to section 704(c)(1)(B).
    (b) Distributee partner's adjusted tax basis in distributed 
property--(1) In general. The distributee partner's adjusted tax basis 
in the distributed property is determined under section 732 (a) or (b) 
as applicable. The increase in the distributee partner's adjusted tax 
basis in the partnership interest under paragraph (a) of this section is 
taken into account in determining the distributee partner's adjusted tax 
basis in the distributed property other than property previously 
contributed by the partner. See Sec. 1.704-4(e)(2) for a determination 
of basis in a distribution subject to section 704(c)(1)(B).
    (2) Previously contributed property. The distributee partner's 
adjusted tax basis in distributed property that the partner previously 
contributed to the partnership is determined as if it were distributed 
in a separate and independent distribution prior to the distribution 
that is subject to section 737 and Sec. 1.737-1.
    (c) Partnership's adjusted tax basis in partnership property--(1) 
Increase in basis. The partnership's adjusted tax basis in eligible 
property is increased by the amount of gain recognized by the 
distributee partner under section 737.
    (2) Eligible property. Eligible property is property that----
    (i) Entered into the calculation of the distributee partner's net 
precontribution gain;
    (ii) Has an adjusted tax basis to the partnership less than the 
property's fair market value at the time of the distribution;
    (iii) Would have the same character of gain on a sale by the 
partnership to an unrelated party as the character of any of the gain 
recognized by the distributee partner under section 737; and
    (iv) Was not distributed to another partner in a distribution 
subject to section 704(c)(1)(B) and Sec. 1.704-4 that was part of the 
same distribution as the distribution subject to section 737.
    (3) Method of adjustment. For the purpose of allocating the basis 
increase under paragraph (c)(2) of this section among the eligible 
property, all eligible property of the same character is treated as a 
single group. Character for this purpose is determined in the same 
manner as the character of the recognized gain is determined under 
Sec. 1.737-1(d). The basis increase is allocated among the separate 
groups of eligible property in proportion to the character of the gain 
recognized under section 737. The basis increase is then allocated among 
property within each group in the order in which the property was 
contributed to the partnership by the partner, starting with the 
property contributed first, in an amount equal to the difference between 
the property's fair market value and its adjusted tax basis to the 
partnership at the time of the distribution. For property that has the 
same character and was contributed in the same (or a related) 
transaction, the basis increase is allocated based on the respective 
amounts of unrealized appreciation in such properties at the time of the 
distribution.
    (4) Section 754 adjustments. The basis adjustments to partnership 
property made pursuant to paragraph (c)(1) of this section are not 
elective and must be made regardless of whether the partnership has an 
election in effect under section 754. Any adjustments to the bases of 
partnership property (including eligible property as defined in 
paragraph (c)(2) of this section) under section 734(b) pursuant to a 
section 754 election (other than basis adjustments under section 
734(b)(1)(A) described in the following sentence) must be made after 
(and must take into account) the adjustments to basis made under 
paragraph (a) and paragraph (c)(1) of this section. Basis adjustments 
under section 734(b)(1)(A) that are attributable to distributions of 
money to the distributee partner that are part of the same distribution 
as the distribution of property subject to section 737 are made before 
the adjustments to basis under paragraph (a) and paragraph (c)(1) of 
this section. See Sec. 1.737-1(c)(2)(ii) for the effect, if any, of 
basis adjustments under section 734(b)(1)(A) on a partner's net 
precontribution gain. See also Sec. 1.704-4(e)(3) for a similar rule 
regarding basis adjustments pursuant to a section 754 election in the 
context of section 704(c)(1)(B).

[[Page 450]]

    (d) Recovery of increase to adjusted tax basis. Any increase to the 
adjusted tax basis of partnership property under paragraph (c)(1) of 
this section is recovered using any applicable recovery period and 
depreciation (or other cost recovery) method (including first-year 
conventions) available to the partnership for newly purchased property 
(of the type adjusted) placed in service at the time of the 
distribution.
    (e) Examples. The following examples illustrate the rules of this 
section. Unless otherwise specified, partnership income equals 
partnership expenses (other than depreciation deductions for contributed 
property) for each year of the partnership, the fair market value of 
partnership property does not change, all distributions by the 
partnership are subject to section 737, and all partners are unrelated.
    Example 1. Partner's basis in distributed property. (i) On January 
1, 1995, A, B, and C form partnership ABC as equal partners. A 
contributes Property A, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $5,000. B contributes 
Property B, nondepreciable real property with a fair market value and 
adjusted tax basis of $10,000. C contributes $10,000 cash.
    (ii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
$5,000 of gain under section 737, an amount equal to the excess 
distribution of $5,000 ($10,000 fair market value of Property B less 
$5,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $5,000 ($10,000 fair market value of Property A 
less $5,000 adjusted tax basis of such property).
    (iii) A's adjusted tax basis in A's partnership interest is 
increased by the $5,000 of gain recognized under section 737. This 
increase is taken into account in determining A's basis in the 
distributed property. Therefore, A's adjusted tax basis in distributed 
Property B is $10,000 under section 732(b).
    Example 2. Partner's basis in distributed property in connection 
with gain recognized under section 704(c)(1)(B). (i) On January 1, 1995, 
A, B, and C form partnership ABC as equal partners. A contributes the 
following nondepreciable real property located in the United States to 
the partnership:

------------------------------------------------------------------------
                                                       Fair             
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................    $10,000      5,000
Property A2.......................................     10,000      2,000
------------------------------------------------------------------------

    (ii) B contributes $10,000 cash and Property B, nondepreciable real 
property located outside the United States, with a fair market value and 
adjusted tax basis of $10,000. C contributes $20,000 cash.
    (iii) On December 31, 1998, Property B is distributed to A in a 
current distribution and Property A1 is distributed to B in a current 
distribution. A recognizes $5,000 of gain under section 704(c)(1)(B) and 
Sec. 1.704-4 on the distribution of Property A1 to B, the difference 
between the fair market value of such property ($10,000) and the 
adjusted tax basis in distributed Property A1 ($5,000). The adjusted tax 
basis of A's partnership interest is increased by this $5,000 of gain 
under section 704(c)(1)(B) and Sec. 1.704-4(e)(1).
    (iv) The increase in the adjusted tax basis of A's partnership 
interest is taken into account in determining the amount of the excess 
distribution. As a result, there is no excess distribution because the 
fair market value of Property B ($10,000) is less than the adjusted tax 
basis of A's interest in the partnership at the time of distribution 
($12,000). A therefore recognizes no gain under section 737 on the 
receipt of Property B. A's adjusted tax basis in Property B is $10,000 
under section 732(a)(1). The adjusted tax basis of A's partnership 
interest is reduced from $12,000 to $2,000 under section 733. See 
Example 3 of Sec. 1.737-1(e).
    Example 3. Partnership's basis in partnership property after a 
distribution with section 737 gain. (i) On January 31, 1995, A, B, and C 
form partnership ABC as equal partners. A contributes the following 
nondepreciable property to the partnership:

------------------------------------------------------------------------
                                                       Fair             
                                                      market    Adjusted
                                                      value    tax basis
------------------------------------------------------------------------
Property A1.......................................     $1,000       $500
Property A2.......................................      4,000      1,500
Property A3.......................................      4,000      6,000
Property A4.......................................      6,000      4,000
------------------------------------------------------------------------

    (ii) The character of gain or loss on Properties A1, A2, and A3 is 
long-term, U.S.-source capital gain or loss. The character of gain on 
Property A4 is long-term, foreign-source capital gain. B contributes 
Property B, nondepreciable real property with a fair market value and 
adjusted tax basis of $15,000. C contributes $15,000 cash.
    (iii) On December 31, 1998, Property B is distributed to A in 
complete liquidation of A's interest in the partnership. A recognizes 
gain of $3,000 under section 737, an amount equal to the excess 
distribution of $3,000 ($15,000 fair market value of Property B less 
$12,000 adjusted tax basis in A's partnership interest) and A's net 
precontribution gain of $3,000 ($15,000 aggregate fair market value of 
the property contributed by A less $12,000 aggregate adjusted tax basis 
of such property).
    (iv) $2,000 of A's gain is long-term, foreign-source capital gain 
($3,000 total gain under

[[Page 451]]

section 737 x $2,000 net long-term, foreign-source capital gain/$3,000 
total net precontribution gain). $1,000 of A's gain is long-term, U.S.-
source capital gain ($3,000 total gain under section 737 x $1,000 net 
long-term, U.S.-source capital gain/$3,000 total net precontribution 
gain).
    (v) The partnership must increase the adjusted tax basis of the 
property contributed by A by $3,000. All property contributed by A is 
eligible property. Properties A1, A2, and A3 have the same character and 
are grouped into a single group for purposes of allocating this basis 
increase. Property A4 is in a separate character group.
    (vi) $2,000 of the basis increase must be allocated to long-term, 
foreign-source capital assets because $2,000 of the gain recognized by A 
was long-term, foreign-source capital gain. The adjusted tax basis of 
Property A4 is therefore increased from $4,000 to $6,000. $1,000 of the 
increase must be allocated to Properties A1 and A2 because $1,000 of the 
gain recognized by A is long-term, U.S.-source capital gain. No basis 
increase is allocated to Property A3 because its fair market value is 
less than its adjusted tax basis. The $1,000 basis increase is allocated 
between Properties A1 and A2 based on the unrealized appreciation in 
each asset before such basis adjustment. As a result, the adjusted tax 
basis of Property A1 is increased by $167 ($1,000 x $500/$3,000) and the 
adjusted tax basis of Property A2 is increased by $833 ($1,000 x $2,500/
3,000).

[T.D. 8642, 60 FR 66736, Dec. 26, 1995; 61 FR 7214, Feb. 27, 1996]



Sec. 1.737-4  Anti-abuse rule.

    (a) In general. The rules of section 737 and Secs. 1.737-1, 1.737-2, 
and 1.737-3 must be applied in a manner consistent with the purpose of 
section 737. Accordingly, if a principal purpose of a transaction is to 
achieve a tax result that is inconsistent with the purpose of section 
737, the Commissioner can recast the transaction for federal tax 
purposes as appropriate to achieve tax results that are consistent with 
the purpose of section 737. Whether a tax result is inconsistent with 
the purpose of section 737 must be determined based on all the facts and 
circumstances. See Sec. 1.704-4(f) for an anti-abuse rule and examples 
in the context of section 704(c)(1)(B). The anti-abuse rule and examples 
under section 704(c)(1)(B) and Sec. 1.704-4(f) are relevant to section 
737 and Secs. 1.737-1, 1.737-2, and 1.737-3 to the extent that the net 
precontribution gain for purposes of section 737 is determined by 
reference to section 704(c)(1)(B).
    (b) Examples. The following examples illustrate the rules of this 
section. The examples set forth below do not delineate the boundaries of 
either permissible or impermissible types of transactions. Further, the 
addition of any facts or circumstances that are not specifically set 
forth in an example (or the deletion of any facts or circumstances) may 
alter the outcome of the transaction described in the example. Unless 
otherwise specified, partnership income equals partnership expenses 
(other than depreciation deductions for contributed property) for each 
year of the partnership, the fair market value of partnership property 
does not change, all distributions by the partnership are subject to 
section 737, and all partners are unrelated.

    Example 1. Increase in distributee partner's basis by temporary 
contribution; results inconsistent with the purpose of section 737. (i) 
On January 1, 1995, A, B, and C form partnership ABC as equal partners. 
A contributes Property A1, nondepreciable real property with a fair 
market value of $10,000 and an adjusted tax basis of $1,000. B 
contributes Property B, nondepreciable real property with a fair market 
value of $10,000 and an adjusted tax basis of $10,000. C contributes 
$10,000 cash.
    (ii) On January 1, 1999, pursuant to a plan a principal purpose of 
which is to avoid gain under section 737, A transfers to the partnership 
Property A2, nondepreciable real property with a fair market value and 
adjusted tax basis of $9,000. A treats the transfer as a contribution to 
the partnership pursuant to section 721 and increases the adjusted tax 
basis of A's partnership interest from $1,000 to $10,000. On January 1, 
1999, the partnership agreement is amended and all other necessary steps 
are taken so that substantially all of the economic risks and benefits 
of Property A2 are retained by A. On February 1, 1999, Property B is 
distributed to A in a current distribution. If the contribution of 
Property A2 is treated as a contribution to the partnership for purposes 
of section 737, there is no excess distribution because the fair market 
value of distributed Property B ($10,000) does not exceed the adjusted 
tax basis of A's interest in the partnership ($10,000), and therefore 
section 737 does not apply. A's adjusted tax basis in distributed 
Property B is $10,000 under section 732(a)(1) and the adjusted tax basis 
of A's partnership interest is reduced to zero under section 733.
    (iii) On March 1, 2000, A receives Property A2 from the partnership 
in complete liquidation of A's interest in the partnership. A recognizes 
no gain on the distribution of Property A2 because the property was 
previously contributed property. See Sec. 1.737-2(d).

[[Page 452]]

    (iv) Although A has treated the transfer of Property A2 as a 
contribution to the partnership that increased the adjusted tax basis of 
A's interest in the partnership, it would be inconsistent with the 
purpose of section 737 to recognize the transfer as a contribution to 
the partnership. Section 737 requires recognition of gain when the value 
of distributed property exceeds the distributee partner's adjusted tax 
basis in the partnership interest. Section 737 assumes that any 
contribution or other transaction that affects a partner's adjusted tax 
basis in the partnership interest is a contribution or transaction in 
substance and is not engaged in with a principal purpose of avoiding 
recognition of gain under section 737. Because the transfer of Property 
A2 to the partnership was not a contribution in substance and was made 
with a principal purpose of avoiding recognition of gain under section 
737, the Commissioner can disregard the contribution of Property A2 for 
this purpose. As a result, A recognizes gain of $9,000 under section 737 
on the receipt of Property B, an amount equal to the lesser of the 
excess distribution of $9,000 ($10,000 fair market value of distributed 
Property B less the $1,000 adjusted tax basis of A's partnership 
interest, determined without regard to the transitory contribution of 
Property A2) or A's net precontribution gain of $9,000 on Property A1.
    Example 2. Increase in distributee partner's basis; section 752 
liability shift; results consistent with the purpose of section 737. (i) 
On January 1, 1995, A and B form general partnership AB as equal 
partners. A contributes Property A, nondepreciable real property with a 
fair market value of $10,000 and an adjusted tax basis of $1,000. B 
contributes Property B, nondepreciable real property with a fair market 
value and adjusted tax basis of $10,000. The partnership also borrows 
$10,000 on a recourse basis and purchases Property C. The $10,000 
liability is allocated equally between A and B under section 752, 
thereby increasing the adjusted tax basis in A's partnership interest to 
$6,000.
    (ii) On December 31, 1998, the partners agree that A is to receive 
Property B in a current distribution. If A were to receive Property B at 
that time, A would recognize $4,000 of gain under section 737, an amount 
equal to the lesser of the excess distribution of $4,000 ($10,000 fair 
market value of Property B less $6,000 adjusted tax basis in A's 
partnership interest) or A's net precontribution gain of $9,000 ($10,000 
fair market value of Property A less $1,000 adjusted tax basis of 
Property A).
    (iii) With a principal purpose of avoiding such gain, A and B agree 
that A will be solely liable for the repayment of the $10,000 
partnership liability and take the steps necessary so that the entire 
amount of the liability is allocated to A under section 752. The 
adjusted tax basis in A's partnership interest is thereby increased from 
$6,000 to $11,000 to reflect A's share of the $5,000 of liability 
previously allocated to B. As a result of this increase in A's adjusted 
tax basis, there is no excess distribution because the fair market value 
of distributed Property B ($10,000) is less than the adjusted tax basis 
of A's partnership interest. Recognizing A's increased adjusted tax 
basis as a result of the shift in liabilities is consistent with the 
purpose of section 737 and this section. Section 737 requires 
recognition of gain only when the value of the distributed property 
exceeds the distributee partner's adjusted tax basis in the partnership 
interest. The $10,000 recourse liability is a bona fide liability of the 
partnership that was undertaken for a substantial business purpose and 
A's and B's agreement that A will assume responsibility for repayment of 
that debt has substance. Therefore, the increase in A's adjusted tax 
basis in A's interest in the partnership due to the shift in partnership 
liabilities under section 752 is respected, and A recognizes no gain 
under section 737.

[T.D. 8642, 60 FR 66738, Dec. 26, 1995]



Sec. 1.737-5  Effective date.

    Sections 1.737-1, 1.737-2, 1.737-3, and 1.737-4 apply to 
distributions by a partnership to a partner on or after January 9, 1995.

[T.D. 8642, 60 FR 66739, Dec. 26, 1995]

                 transfers of interests in a partnership



Sec. 1.741-1   Recognition and character of gain or loss on sale or exchange.

    (a) The sale or exchange of an interest in a partnership shall, 
except to the extent section 751(a) applies, be treated as the sale or 
exchange of a capital asset, resulting in capital gain or loss measured 
by the difference between the amount realized and the adjusted basis of 
the partnership interest, as determined under section 705. For treatment 
of selling partner's distributive share up to date of sale, see section 
706(c)(2). Where the provisions of section 751 require the recognition 
of ordinary income or loss with respect to a portion of the amount 
realized from such sale or exchange, the amount realized shall be 
reduced by the amount attributable under section 751 to unrealized 
receivables and substantially appreciated inventory items, and the 
adjusted basis of the transferor partner's interest in the partnership 
shall be reduced by the

[[Page 453]]

portion of such basis attributable to such unrealized receivables and 
substantially appreciated inventory items. See section 751 and 
Sec. 1.751-1.
    (b) Section 741 shall apply whether the partnership interest is sold 
to one or more members of the partnership or to one or more persons who 
are not members of the partnership. Section 741 shall also apply even 
though the sale of the partnership interest results in a termination of 
the partnership under section 708(b). Thus, the provisions of section 
741 shall be applicable (1) to the transferor partner in a 2-man 
partnership when he sells his interest to the other partner, and (2) to 
all the members of a partnership when they sell their interests to one 
or more persons outside the partnership.
    (c) See section 351 for nonrecognition of gain or loss upon transfer 
of a partnership interest to a corporation controlled by the transferor.
    (d) For rules relating to the treatment of liabilities on the sale 
or exchange of interests in a partnership see Secs. 1.752-1 and 1.1001-
2.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960; 25 FR 14021, Dec. 31, 1960, as 
amended by T.D. 7741, 45 FR 81745, Dec. 12, 1980]



Sec. 1.742-1   Basis of transferee partner's interest.

    The basis to a transferee partner of an interest in a partnership 
shall be determined under the general basis rules for property provided 
by part II (section 1011 and following), subchapter O, chapter 1 of the 
Code. Thus, the basis of a purchased interest will be its cost. The 
basis of a partnership interest acquired from a decedent is the fair 
market value of the interest at the date of his death or at the 
alternate valuation date, increased by his estate's or other successor's 
share of partnership liabilities, if any, on that date, and reduced to 
the extent that such value is attributable to items constituting income 
in respect of a decedent (see section 753 and paragraph (c)(3)(v) of 
Sec. 1.706-1 and paragraph (b) of Sec. 1.753-1) under section 691. See 
section 1014(c). For basis of contributing partner's interest, see 
section 722. The basis so determined is then subject to the adjustments 
provided in section 705.



Sec. 1.743-1   Optional adjustment to basis of partnership property.

    (a) General rule. The basis of partnership property shall not be 
adjusted as the result of a transfer of an interest in a partnership, 
either by sale or exchange or as a result of the death of a partner, 
unless the election provided by section 754 (relating to optional 
adjustment to basis of partnership property) is in effect with respect 
to the partnership. However, whether or not the election provided in 
section 754 is in effect, the basis of partnership property shall not be 
adjusted as the result of a contribution of property, including money, 
to the partnership.
    (b) Adjustment to basis of partnership property--(1) Determination 
of adjustment. In the case of a transfer of an interest in a 
partnership, either by sale or exchange or as a result of the death of a 
partner, a partnership as to which the election under section 754 is in 
effect shall:
    (i) Increase the adjusted basis of partnership property by the 
excess of the transferee's basis for his partnership interest over his 
share of the adjusted basis to the partnership of all partnership 
property, or
    (ii) Decrease the adjusted basis of partnership property by the 
excess of the transferee partner's share of the adjusted basis of all 
partnership property over his basis for his partnership interest.

The amount of the increase or decrease constitutes an adjustment 
affecting the basis of partnership property with respect to the 
transferee partner only. Thus, for purposes of depreciation, depletion, 
gain or loss, and distributions, the transferee partner will have a 
special basis for those partnership properties which are adjusted under 
section 743(b) and this paragraph. This special basis is his share of 
the common partnership basis (i.e., the adjusted basis of such 
properties to the partnership without regard to any special basis 
adjustments of any transferee) plus or minus his special basis 
adjustments. A partner's share of the adjusted basis of partnership 
property is equal to the sum of his interest as a partner in partnership 
capital and surplus, plus his share of partnership liabilities. Where

[[Page 454]]

an agreement with respect to contributed property is in effect under 
section 704(c)(2), such agreement shall be taken into account in 
determining a partner's share of the adjusted basis of partnership 
property. Generally, if a partner's interest in partnership capital and 
profits is one-third, his share of the adjusted basis of partnership 
property will be one-third of such basis. The provisions of this 
paragraph may be illustrated by the following examples:

    Example 1. A is a member of partnership ABC in which the partners 
have equal interests in capital and profits. The partnership has made 
the election under section 754, relating to the optional adjustment to 
the basis of partnership property. A sells his interest to P for 
$22,000. The balance sheet of the partnership at the date of sale shows 
the following:

                                 Assets                                 
------------------------------------------------------------------------
                                                     Adjusted           
                                                    basis per    Market 
                                                      books      value  
------------------------------------------------------------------------
Cash..............................................     $5,000     $5,000
Accounts receivable...............................     10,000     10,000
Inventory.........................................     20,000     21,000
Depreciable assets................................     20,000     40,000
                                                   ---------------------
    Total.........................................     55,000     76,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                     Adjusted           
                                                    basis per    Value  
                                                      books             
------------------------------------------------------------------------
Liabilities.......................................    $10,000    $10,000
Capital:                                                                
  A...............................................     15,000     22,000
  B...............................................     15,000     22,000
  C...............................................     15,000     22,000
                                                   ---------------------
    Total.........................................     55,000     76,000
------------------------------------------------------------------------

The amount of the adjustment under section 743(b) is the difference 
between the basis of the transferee's interest in the partnership and 
his share of the adjusted basis of partnership property. Under section 
742, the basis of P's interest is $25,333 (the cash paid for A's 
interest, $22,000, plus $3,333, P's share of partnership liabilities). 
P's share of the adjusted basis of partnership property is $18,333, 
i.e., $15,000 plus $3,333. The amount to be added to the basis of 
partnership property is, therefore, $7,000, the difference between 
$25,333 and $18,333. This amount will be allocated to partnership 
properties in accordance with the rules set forth in section 755 and 
Sec. 1.755-1.
    Example 2. D is a member of partnership DEF in which the partners 
have equal interests in profits, but not in capital. The partnership has 
made the election under section 754. D dies and his interest passes to 
W, his widow. The balance sheet of the partnership at the date of D's 
death shows the following:

                                 Assets                                 
------------------------------------------------------------------------
                                                     Adjusted           
                                                    basis per    Market 
                                                      books      value  
------------------------------------------------------------------------
Cash..............................................     $7,000     $7,000
Accounts receivable...............................     10,000     10,000
Inventory.........................................     20,000     24,000
Depreciable assets................................     20,000     40,000
                                                   ---------------------
    Total.........................................     57,000     81,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                     Adjusted           
                                                    basis per    Value  
                                                      books             
------------------------------------------------------------------------
Liabilities.......................................    $10,000    $10,000
Capital:                                                                
  D...............................................     18,000     26,000
  E...............................................     15,000     23,000
  F...............................................     14,000     22,000
                                                   ---------------------
    Total.........................................     57,000     81,000
------------------------------------------------------------------------

The amount of the adjustment under section 743(b) is the difference 
between the basis of the transferee's interest in the partnership and 
her share of the adjusted basis of partnership property. Under section 
742, the basis of W's interest is $29,333 (the fair market value of D's 
interest at his death, $26,000, plus $3,333, his share of partnership 
liabilities). W's share of the adjusted basis of partnership property is 
$21,333 (i.e., $18,000 plus $3,333, her share of partnership 
liabilities). The amount to be added to the basis of partnership 
property is, therefore, $8,000, the difference between $29,333 and 
$21,333. This amount will be allocated to partnership properties in 
accordance with the rules set forth in section 755 and Sec. 1.755-1.

Note that in examples 1 and 2 of this subparagraph the amount of the 
adjustment does not depend upon the adjusted basis to the transferor for 
his interest in partnership capital.
    (2) Determination of partner's share of adjusted basis of 
partnership property. (i) Under the provisions of section 743(b), a 
partner's share of the adjusted basis of partnership property shall be 
determined by taking into account the effect of any partnership 
agreement with respect to contributed property as described in section 
704(c)(2), or the effect of the contribution of undivided interests 
under section 704(c)(3). This rule may be illustrated by the following 
examples:


[[Page 455]]


    Example 1. A, B, and C form partnership ABC, to which A contributes 
land worth $1,000 (property X) with an adjusted basis to him of $400, 
and B and C each contributes $1,000 cash. Each partner has $1,000 
credited to him on the books of the partnership as his capital 
contribution. The partners share in profits equally. During the 
partnership's first taxable year, property X appreciates in value to 
$1,300. A sells his one-third interest in the partnership to D for 
$1,100, when the election under section 754 is in effect. No agreement 
under section 704(c)(2) is in effect. The adjusted basis of the 
partnership property is increased with respect to D by the excess of his 
basis for his partnership interest, $1,100, over his share of the 
adjusted basis of partnership property, $800 ( 1/3 of $2,400, the total 
adjusted basis of partnership property). The amount of the adjustment, 
therefore, is $300 ($1,100 minus $800), which is an increase in the 
basis of partnership property with respect to D only. This special basis 
adjustment will be allocated to property X. (See section 755 and 
Sec. 1.755-1.) If property X is sold for $1,600, the gain to the 
partnership is $1,200 ($1,600 received, less the adjusted common 
partnership basis of $400 for property X). Thus, each partner's 
distributive share of the gain on the sale is $400. However, D's 
recognized gain is only $100 (his $400 distributive share of the gain, 
reduced by $300, his special basis adjustment with respect to property 
X). If D purchased his interest from B or C, the partners who 
contributed cash, D's adjustment under section 743(b) would also be 
$300, computed in exactly the same manner as in the case of a purchase 
from A.
    Example 2. Assume that partnership ABC described in example 1 of 
this subdivision has an agreement under section 704(c)(2) with respect 
to property X, stating that upon the sale of that property any gain, to 
the extent attributable to the precontribution appreciation of $600 (the 
difference between its value, $1,000, and its basis, $400, at the time 
of the contribution) is to be allocated entirely to A, who contributed 
property X. Upon the purchase of A's interest by D for $1,100, the 
computation of D's special basis would differ from that indicated in 
example 1 of this subdivision as follows: Under the partnership 
agreement, A's share of the $2,400 adjusted basis of partnership 
property is only $400 (his basis for property X prior to its 
contribution to the partnership), and B's and C's share is $1,000 each 
(the amount of the cash investment of each). The amount of the increase 
to D in the adjusted basis of partnership property under section 
743(b)(1) is $700 (the excess of $1,100, D's cost basis for his 
interest, over $400, A's share of the adjusted basis of partnership 
property to which D succeeds). This amount constitutes an adjustment to 
the basis of partnership property with respect to D only. If X is sold 
by the partnership for $1,600, the gain is $1,200 ($1,600 received less 
the adjusted common partnership basis of $400). Under the partnership 
agreement, $600 of this gain, which is attributable to precontribution 
appreciation in value, is allocable to D, who is A's successor. The 
remaining $600 gain is not subject to the agreement and is allocable to 
the partners equally, $200 each. D's distributive share of the 
partnership gain is thus $600 plus $200, or $800. However, D has a 
special basis adjustment of $700 under section 743(b)(1), which reduces 
his gain from $800 to $100. B and C each has a gain of $200, which is 
unaffected by the transfer of A's interest to D.
    Example 3. Assume the same facts as in example 2 of this 
subdivision, except that D has purchased his interest from B instead of 
from A. His special basis adjustment for partnership property in this 
case differs from that where he had purchased his interest from A, 
because of the effect of the agreement under section 704(c)(2). In this 
case, D is a successor to B, whose share of the adjusted basis of 
partnership property is $1,000, instead of A, whose share is only $400. 
As a result, the adjustment under section 743(b)(1) is the excess of D's 
cost basis for his interest, $1,100, over his share of the adjusted 
basis of partnership property, $1,000, or $100. In this case, if 
property X is sold for $1,600, the partnership gain is $1,200 ($1,600 
less the adjusted partnership basis of $400). Of this gain, $600, 
representing precontribution appreciation, is allocable to A under the 
partnership agreement. The remaining $600 is allocable in the amount of 
$200 to each partner. Since D as a transferee has a special basis 
adjustment of $100 under section 743(b)(1), his gain is reduced from 
$200 to $100.

    (ii) If a partner receives a distribution of property with respect 
to which another partner has a special basis adjustment, the distributee 
shall not take into account the special basis adjustment of the other 
partner. However, the partner with the special basis adjustment will 
reallocate it under section 755 to remaining partnership property of a 
like kind or, if he receives a distribution of like property, to such 
distributed property. If a partner receives a distribution of property 
with respect to which he has a special basis adjustment, such basis 
adjustment will be taken into account when relevant under section 732. 
See paragraph (b) of Sec. 1.732-2. If, at the time a partner receives 
property (whether or not he has a special basis adjustment with respect 
to such property), he relinquishes his interest in other property of a 
like kind with respect to which he has a special basis adjustment, the 
adjusted

[[Page 456]]

basis to the partnership of the distributed property shall include his 
special basis adjustment for the property in which he relinquished his 
interest. For the purposes of the preceding sentence, a partner will be 
considered as having relinquished his interest in any remaining 
partnership properties when his interest has been completely liquidated; 
however, when a partner receives a distribution not in liquidation, he 
will be considered as relinquishing his interest only in property 
distributed to other partners. For the purposes of this subdivision, 
like property means property of the same class, that is, stock in trade, 
property used in the trade or business, capital assets, etc. For certain 
adjustments to the basis of remaining partnership property after a 
distribution to a transferee partner, see paragraph (b) of Sec. 1.734-2. 
The provisions of this subdivision may be illustrated by the following 
examples:

    Example 1. C is a transferee partner in partnership BC. The 
partnership owns, among other assets, X, a depreciable asset with a 
common basis to the partnership of $1,000 and a special basis adjustment 
to C of $200, and Y, another depreciable asset with a common basis of 
$800 and a special basis adjustment to C of $300. B and C agree that B 
will receive a distribution of property Y, and C will receive a 
distribution of property X, with all other property to remain in the 
partnership. With respect to B, the partnership basis of property Y is 
$800, the common partnership basis. Y will, therefore, have a basis of 
$800 in B's hands under section 732(a) which provides for the use of a 
carryover basis in the case of current distributions. With respect to C, 
however, the partnership basis of property X is $1,500, the common 
partnership basis of $1,000, plus C's special basis adjustment of $200 
for property X, plus C's additional special basis adjustment of $300 for 
property Y, in which he has relinquished his interest.
    Example 2. (a) Partner D acquired his one-third interest in 
partnership BCD for $14,000 from a previous partner when an election 
under section 754 was in effect. Therefore, under section 743(b), D has 
a special basis adjustment for certain partnership property. Assume that 
at the time of the distribution in paragraph (b) of this example, the 
partnership assets consist of cash and rental property and that such 
assets and D's special basis adjustments under section 743(b) are as 
follows:

----------------------------------------------------------------------------------------------------------------
                                                                                             D's                
                                                           Fair       Common      D's      special   Partnership
                         Item                             market   partnership   share      basis     basis to D
                                                          value       basis              adjustment             
----------------------------------------------------------------------------------------------------------------
Cash..................................................  $12,000     $12,000      $4,000  ..........     $4,000  
House:                                                                                                          
  U...................................................    9,000       1,200         400  ..........        400  
  V...................................................    6,000       4,500       1,500  ..........      1,500  
  W...................................................    8,000       1,500         500  ..........        500  
  X...................................................    9,000       4,800       1,600     $2,000       3,600  
  Y...................................................    9,000       6,000       2,000  ..........      2,000  
  Z...................................................    7,000       3,000       1,000      1,000       2,000  
                                                       ---------------------------------------------------------
    Total.............................................   60,000      33,000      11,000      3,000      14,000  
----------------------------------------------------------------------------------------------------------------

    (b) Assume further that D receives $4,000 in cash and houses Y and Z 
in complete liquidation of his interest in partnership BCD. In 
determining the basis to D of houses Y and Z under section 732 (b) and 
(c), D must allocate $10,000 basis ($14,000 basis for his interest, less 
$4,000 cash received) to houses Y and Z in proportion to their adjusted 
basis to the partnership. For purposes of section 732(c), the adjusted 
basis of house Y is $7,200. ($6,000 common partnership basis, plus 
$1,200, allocated share of D's special basis adjustment of $2,000 for 
house X, in which D relinquished his interest). The adjusted basis of 
house Z is $4,800 ($3,000 common partnership basis, plus $1,000, D's 
special basis for house Z, plus $800, allocated share of D's special 
basis of $2,000 for house X, in which D relinquished his interest). 
Under the rule of this subdivision, 6,000/10,000 of the $2,000 special 
basis adjustment for X is allocated to Y and 4,000/10,000 of such amount 
to Z. Therefore, $6,000 basis (7,200/12,000 of $10,000) is allocated to 
house Y and $4,000 basis (4,800/12,000 of $10,000) to house Z.
    (c) Since houses Y and Z had $12,000 basis to the partnership, as 
computed in paragraph (b) of this example, and only $10,000 basis to D, 
as determined under section 732, the partnership, under section 
734(b)(1)(B), must increase the basis of remaining partnership property 
(houses U, V, W, and X) by $2,000 (excess of $12,000 over $10,000). For 
allocation of this amount, see section 755 and Sec. 1.755-1.


[[Page 457]]


    (iii) Where an adjustment is made under section 743(b) to the basis 
of partnership property subject to depletion, any depletion allowable 
shall be determined separately for each partner, including the 
transferee partner, based on his interest in such property. See 
paragraph (a)(8) of Sec. 1.702-1. This rule may be illustrated by the 
following example:

    Example. A, B, and C each contributes $5,000 cash to form 
partnership ABC, which purchases oil property for $15,000. C 
subsequently sells his partnership interest to D for $100,000 when the 
election under section 754 is in effect. D has a special basis 
adjustment for the oil property of $95,000 (the difference between D's 
basis, $100,000, and his share of the basis of partnership property, 
$5,000). Assume that the depletion allowance computed under the 
percentage method would be $21,000 for the taxable year so that each 
partner would be entitled to $7,000 as his share of the deduction for 
depletion. However, under the cost depletion method, at an assumed rate 
of 10 percent, the allowance with respect to D's one-third interest 
which has a basis to him of $100,000 ($5,000, plus his special basis 
adjustment of $95,000) is $10,000, although the cost depletion allowance 
with respect to the one-third interest of A and B in the oil property, 
each of which has a basis of $5,000, is only $500. For partners A and B, 
the percentage depletion is greater than cost depletion and each will 
deduct $7,000 based on the percentage depletion method. However, as to 
D, the transferee partner, the cost depletion method results in a 
greater allowance and D will, therefore, deduct $10,000 based on cost 
depletion. See section 613(a).

    (iv) Where there has been more than one transfer of partnership 
interests, the last transferee's special basis adjustment, if any, under 
section 743(b) shall be determined by reference to the partnership 
common basis for its property without regard to any prior transferee's 
special basis adjustment. For example, A, B, and C form a partnership. A 
and B each contributes $1,000 cash and C contributes land with a basis 
and value of $1,000. When the land has appreciated in value to $1,300, A 
sells his interest to D for $1,100 ( 1/3 of $3,300, the value of the 
partnership property). The election under section 754 is in effect; 
therefore, D has a special basis adjustment of $100 with respect to the 
land under section 743(b). After the land has further appreciated in 
value to $1,600, D sells his interest to E for $1,200 ( 1/3 of $3,600, 
the value of the partnership property). Under section 743(b), E has a 
special basis adjustment of $200. This amount is determined without 
regard to any special basis adjustment that D may have had in the 
partnership assets.
    (3) Returns. A transferee partner who has a special basis adjustment 
under section 743(b) shall attach a statement to his income tax return 
for the first taxable year in which the basis of any partnership 
property subject to the adjustment is pertinent in determining his 
income tax, showing the computation of the adjustment and the 
partnership properties to which the adjustment has been allocated.
    (c) Allocation of basis. For the allocation of basis among 
partnership properties where section 743 (b) applies, see section 755 
and Sec. 1.755-1.

    provisions common to part ii, subchapter k, chapter 1 of the code



Sec. 1.751-1   Unrealized receivables and inventory items.

    (a) Sale or exchange of interest in a partnership--(1) Character of 
amount realized. To the extent that money or property received by a 
partner in exchange for all or part of his partnership interest is 
attributable to his share of the value of partnership unrealized 
receivables or substantially appreciated inventory items, the money or 
fair market value of the property received shall be considered as an 
amount realized from the sale or exchange of property other than a 
capital asset. The remainder of the total amount realized on the sale or 
exchange of the partnership interest is realized from the sale or 
exchange of a capital asset under section 741. For definition of 
``unrealized receivables'' and ``inventory items which have appreciated 
substantially in value'', see section 751 (c) and (d). Unrealized 
receivables and substantially appreciated inventory items are hereafter 
in this section referred to as ``section 751 property''. See paragraph 
(e) of this section.
    (2) Determination of gain or loss. The income or loss realized by a 
partner upon the sale or exchange of his interest in section 751 
property is the difference between (i) the portion of the

[[Page 458]]

total amount realized for the partnership interest allocated to section 
751 property, and (ii) the portion of the selling partner's basis for 
his entire interest allocated to such property. Generally, the portion 
of the total amount realized which the seller and the purchaser allocate 
to section 751 property in an arm's length agreement will be regarded as 
correct. The portion of the partner's adjusted basis for his partnership 
interest to be allocated to section 751 property shall be an amount 
equal to the basis such property would have had under section 732 
(including subsection (d) thereof) if the selling partner had received 
his share of such properties in a current distribution made immediately 
before the sale. See Secs. 1.732-1 and 1.732-2. Such basis shall reflect 
the rules of section 704(c)(3), if applicable, or any agreement under 
section 704(c)(2). Any gain or loss recognized which is attributable to 
section 751 property will be ordinary gain or loss. The difference 
between the remainder, if any, of the partner's adjusted basis for his 
partnership interest and the balance, if any, of the amount realized is 
the transferor's capital gain or loss on the sale of his partnership 
interest.
    (3) Statement required. A transferor partner selling or exchanging 
any part of his interest in a partnership which has any section 751 
property at the time of sale or exchange shall submit with his income 
tax return for the taxable year in which the sale or exchange occurs a 
statement setting forth separately the following information:
    (i) The date of the sale or exchange, the amount of the transferor 
partner's adjusted basis for his partnership interest, and the portion 
thereof attributable to section 751 property under section 732; and
    (ii) The amount of any money and the fair market value of any other 
property received or to be received for the transferred interest in the 
partnership, and the portion thereof attributable to section 751 
property.
    (iii) If the transferor partner computes his adjusted basis for 
section 751 property under the provisions of section 732(d), he must 
also include in the statement the information required by paragraph 
(d)(3) of Sec. 1.732-1.
    (iv) If the transferor partner has a special basis adjustment under 
section 743(b), he must also include in the statement the computation of 
his special basis adjustment and the partnership properties to which the 
adjustment has been allocated.
    (b) Certain distributions treated as sales or exchanges--(1) In 
general. (i) Certain distributions to which section 751(b) applies are 
treated in part as sales or exchanges of property between the 
partnership and the distributee partner, and not as distributions to 
which sections 731 through 736 apply. A distribution treated as a sale 
or exchange under section 751(b) is not subject to the provisions of 
section 707(b). Section 751(b) applies whether or not the distribution 
is in liquidation of the distributee partner's entire interest in the 
partnership. However, section 751(b) applies only to the extent that a 
partner either receives section 751 property in exchange for his 
relinquishing any part of his interest in other property, or receives 
other property in exchange for his relinquishing any part of his 
interest in section 751 property.
    (ii) Section 751(b) does not apply to a distribution to a partner 
which is not in exchange for his interest in other partnership property. 
Thus, section 751(b) does not apply to the extent that a distribution 
consists of the distributee partner's share of section 751 property or 
his share of other property. Similarly, section 751(b) does not apply to 
current drawings or to advances against the partner's distributive 
share, or to a distribution which is, in fact, a gift or payment for 
services or for the use of capital. In determining whether a partner has 
received only his share of either section 751 property or of other 
property, his interest in such property remaining in the partnership 
immediately after a distribution must be taken into account. For 
example, the section 751 property in partnership ABC has a fair market 
value of $100,000 in which partner A has an interest of 30 percent, or 
$30,000. If A receives $20,000 of section 751 property in a 
distribution, and continues to have a 30-percent interest in the $80,000 
of section 751 property remaining in the partnership after the 
distribution, only $6,000 ($30,000 minus $24,000 (30 percent of

[[Page 459]]

$80,000)) of the section 751 property received by him will be considered 
to be his share of such property. The remaining $14,000 ($20,000 minus 
$6,000) received is in excess of his share.
    (iii) If a distribution is, in part, a distribution of the 
distributee partner's share of section 751 property, or of other 
property (including money) and, in part, a distribution in exchange of 
such properties, the distribution shall be divided for the purpose of 
applying section 751(b). The rules of section 751(b) shall first apply 
to the part of the distribution treated as a sale or exchange of such 
properties, and then the rules of sections 731 through 736 shall apply 
to the part of the distribution not treated as a sale or exchange. See 
paragraph (b)(4)(ii) of this section for treatment of payments under 
section 736(a).
    (2) Distribution of section 751 property (unrealized receivables or 
substantially appreciated inventory items). (i) To the extent that a 
partner receives section 751 property in a distribution in exchange for 
any part of his interest in partnership property (including money) other 
than section 751 property, the transaction shall be treated as a sale or 
exchange of such properties between the distributee partner and the 
partnership (as constituted after the distribution).
    (ii) At the time of the distribution, the partnership (as 
constituted after the distribution) realizes ordinary income or loss on 
the sale or exchange of the section 751 property. The amount of the 
income or loss to the partnership will be measured by the difference 
between the adjusted basis to the partnership of the section 751 
property considered as sold to or exchanged with the partner, and the 
fair market value of the distributee partner's interest in other 
partnership property which he relinquished in the exchange. In computing 
the partners' distributive shares of such ordinary income or loss, the 
income or loss shall be allocated only to partners other than the 
distributee and separately taken into account under section 702(a)(8).
    (iii) At the time of the distribution, the distributee partner 
realizes gain or loss measured by the difference between his adjusted 
basis for the property relinquished in the exchange (including any 
special basis adjustment which he may have) and the fair market value of 
the section 751 property received by him in exchange for his interest in 
other property which he has relinquished. The distributee's adjusted 
basis for the property relinquished is the basis such property would 
have had under section 732 (including subsection (d) thereof) if the 
distributee partner had received such property in a current distribution 
immediately before the actual distribution which is treated wholly or 
partly as a sale or exchange under section 751(b). The character of the 
gain or loss to the distributee partner shall be determined by the 
character of the property in which he relinquished his interest.
    (3) Distribution of partnership property other than section 751 
property. (i) To the extent that a partner receives a distribution of 
partnership property (including money) other than section 751 property 
in exchange for any part of his interest in section 751 property of the 
partnership, the distribution shall be treated as a sale or exchange of 
such properties between the distributee partner and the partnership (as 
constituted after the distribution).
    (ii) At the time of the distribution, the partnership (as 
constituted after the distribution) realizes gain or loss on the sale or 
exchange of the property other than section 751 property. The amount of 
the gain to the partnership will be measured by the difference between 
the adjusted basis to the partnership of the distributed property 
considered as sold to or exchanged with the partner, and the fair market 
value of the distributee partner's interest in section 751 property 
which he relinquished in the exchange. The character of the gain or loss 
to the partnership is determined by the character of the distributed 
property treated as sold or exchanged by the partnership. In computing 
the partners' distributive shares of such gain or loss, the gain or loss 
shall be allocated only to partners other than the distributee and 
separately taken into account under section 702(a)(8).

[[Page 460]]

    (iii) At the time of the distribution, the distributee partner 
realizes ordinary income or loss on the sale or exchange of the section 
751 property. The amount of the distributee partner's income or loss 
shall be measured by the difference between his adjusted basis for the 
section 751 property relinquished in the exchange (including any special 
basis adjustment which he may have), and the fair market value of other 
property (including money) received by him in exchange for his interest 
in the section 751 property which he has relinquished. The distributee 
partner's adjusted basis for the section 751 property relinquished is 
the basis such property would have had under section 732 (including 
subsection (d) thereof) if the distributee partner had received such 
property in a current distribution immediately before the actual 
distribution which is treated wholly or partly as a sale or exchange 
under section 751(b).
    (4) Exceptions. (i) Section 751(b) does not apply to the 
distribution to a partner of property which the distributee partner 
contributed to the partnership. The distribution of such property is 
governed by the rules set forth in sections 731 through 736, relating to 
distributions by a partnership.
    (ii) Section 751(b) does not apply to payments made to a retiring 
partner or to a deceased partner's successor in interest to the extent 
that, under section 736(a), such payments constitute a distributive 
share of partnership income or guaranteed payments. Payments to a 
retiring partner or to a deceased partner's successor in interest for 
his interest in unrealized receivables of the partnership in excess of 
their partnership basis, including any special basis adjustment for them 
to which such partner is entitled, constitute payments under section 
736(a) and, therefore, are not subject to section 751(b). However, 
payments under section 736(b) which are considered as made in exchange 
for an interest in partnership property are subject to section 751(b) to 
the extent that they involve an exchange of substantially appreciated 
inventory items for other property. Thus, payments to a retiring partner 
or to a deceased partner's successor in interest under section 736 must 
first be divided between payments under section 736(a) and section 
736(b). The section 736(b) payments must then be divided, if there is an 
exchange of substantially appreciated inventory items for other 
property, between the payments treated as a sale or exchange under 
section 751(b) and payments treated as a distribution under sections 731 
through 736. See subparagraph (1)(iii) of this paragraph, and section 
736 and Sec. 1.736-1.
    (5) Statement required. A partnership which distributes section 751 
property to a partner in exchange for his interest in other partnership 
property, or which distributes other property in exchange for any part 
of the partner's interest in section 751 property, shall submit with its 
return for the year of the distribution a statement showing the 
computation of any income, gain, or loss to the partnership under the 
provisions of section 751(b) and this paragraph. The distributee partner 
shall submit with his return a statement showing the computation of any 
income, gain, or loss to him. Such statement shall contain information 
similar to that required under paragraph (a)(3) of this section.
    (c) Unrealized receivables. (1) The term unrealized receivables, as 
used in subchapter K, chapter 1 of the Code, means any rights 
(contractual or otherwise) to payment for:
    (i) Goods delivered or to be delivered (to the extent that such 
payment would be treated as received for property other than a capital 
asset), or
    (ii) Services rendered or to be rendered,

to the extent that income arising from such rights to payment was not 
previously includible in income under the method of accounting employed 
by the partnership. Such rights must have arisen under contracts or 
agreements in existence at the time of sale or distribution, although 
the partnership may not be able to enforce payment until a later time. 
For example, the term includes trade accounts receivable of a cash 
method taxpayer, and rights to payment for work or goods begun but 
incomplete at the time of the sale or distribution.

[[Page 461]]

    (2) The basis for such unrealized receivables shall include all 
costs or expenses attributable thereto paid or accrued but not 
previously taken into account under the partnership method of 
accounting.
    (3) In determining the amount of the sale price attributable to such 
unrealized receivables, or their value in a distribution treated as a 
sale or exchange, any arm's length agreement between the buyer and the 
seller, or between the partnership and the distributee partner, will 
generally establish the amount or value. In the absence of such an 
agreement, full account shall be taken not only of the estimated cost of 
completing performance of the contract or agreement, but also of the 
time between the sale or distribution and the time of payment.
    (4)(i) With respect to any taxable year of a partnership ending 
after September 12, 1966 (but only in respect of expenditures paid or 
incurred after that date), the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from mining property defined in section 617(f)(2). With 
respect to each item of partnership mining property so defined, the 
potential gain is the amount that would be treated as gain to which 
section 617(d)(1) would apply if (at the time of the transaction 
described in section 731, 736, 741, or 751, as the case may be) the item 
were sold by the partnership at its fair market value.
    (ii) With respect to sales, exchanges, or other dispositions after 
December 31, 1975, in any taxable year of a partnership ending after 
that date, the term unrealized receivables, for purposes of this section 
and sections 731, 736, 741, and 751, also includes potential gain from 
stock in a DISC as described in section 992(a). With respect to stock in 
such a DISC, the potential gain is the amount that would be treated as 
gain to which section 995(c) would apply if (at the time of the 
transaction described in section 731, 736, 741, or 751, as the case may 
be) the stock were sold by the partnership at its fair market value.
    (iii) With respect to any taxable year of a partnership beginning 
after December 31, 1962, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from section 1245 property. With respect to each item of 
partnership section 1245 property (as defined in section 1245(a)(3)), 
potential gain from section 1245 property is the amount that would be 
treated as gain to which section 1245(a)(1) would apply if (at the time 
of the transaction described in section 731, 736, 741, or 751, as the 
case may be) the item of section 1245 property were sold by the 
partnership at its fair market value. See Sec. 1.1245-1(e)(1). For 
example, if a partnership would recognize under section 1245(a)(1) gain 
of $600 upon a sale of one item of section 1245 property and gain of 
$300 upon a sale of its only other item of such property, the potential 
section 1245 income of the partnership would be $900.
    (iv) With respect to transfers after October 9, 1975, and to sales, 
exchanges, and distributions taking place after that date, the term 
unrealized receivables, for purposes of this section and sections 731, 
736, 741, and 751, also includes potential gain from stock in certain 
foreign corporations as described in section 1248. With respect to stock 
in such a foreign corporation, the potential gain is the amount that 
would be treated as gain to which section 1248(a) would apply if (at the 
time of the transaction described in section 731, 736, 741, or 751, as 
the case may be) the stock were sold by the partnership at its fair 
market value.
    (v) With respect to any taxable year of a partnership ending after 
December 31, 1963, the term unrealized receivables, for purposes of this 
section and sections 731, 736, 741, and 751, also includes potential 
gain from section 1250 property. With respect to each item of 
partnership section 1250 property (as defined in section 1250(c)), 
potential gain from section 1250 property is the amount that would be 
treated as gain to which section 1250(a) would apply if (at the time of 
the transaction described in section 731, 736, 741, or 751, as the case 
may be) the item of section 1250 property were sold by the partnership 
at its fair market value. See Sec. 1.1250-1(f)(1).

[[Page 462]]

    (vi) With respect to any taxable year of a partnership beginning 
after December 31, 1969, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from farm recapture property as defined in section 
1251(e)(1) (as in effect before enactment of the Tax Reform Act of 
1984). With respect to each item of partnership farm recapture property 
so defined, the potential gain is the amount which would be treated as 
gain to which section 1251(c) (as in effect before enactment of the Tax 
Reform Act of 1984) would apply if (at the time of the transaction 
described in section 731, 736, 741, or 751, as the case may be) the item 
were sold by the partnership at its fair market value.
    (vii) With respect to any taxable year of a partnership beginning 
after December 31, 1969, the term unrealized receivables, for purposes 
of this section and sections 731, 736, 741, and 751, also includes 
potential gain from farm land as defined in section 1252(a)(2). With 
respect to each item of partnership farm land so defined, the potential 
gain is the amount that would be treated as gain to which section 
1252(a)(1) would apply if (at the time of the transaction described in 
section 731, 736, 741, or 751, as the case may be) the item were sold by 
the partnership at its fair market value.
    (viii) With respect to transactions which occur after December 31, 
1976, in any taxable year of a partnership ending after that date, the 
term unrealized receivables, for purposes of this section and sections 
731, 736, 741, and 751, also includes potential gain from franchises, 
trademarks, or trade names referred to in section 1253(a). With respect 
to each such item so referred to in section 1253(a), the potential gain 
is the amount that would be treated as gain to which section 1253(a) 
would apply if (at the time of the transaction described in section 731, 
736, 741, or 751, as the case may be) the items were sold by the 
partnership at its fair market value.
    (ix) With respect to any taxable year of a partnership ending after 
December 31, 1975, the term unrealized receivables, for purposes of this 
section and sections 731, 736, 741, and 751, also includes potential 
gain under section 1254(a) from natural resource recapture property as 
defined in Sec. 1.1254-1(b)(2). With respect to each separate 
partnership natural resource recapture property so described, the 
potential gain is the amount that would be treated as gain to which 
section 1254(a) would apply if (at the time of the transaction described 
in section 731, 736, 741, or 751, as the case may be) the property were 
sold by the partnership at its fair market value.
    (x) For purposes of section 751(c) and this paragraph (c)(4), any 
arm's-length agreement between the buyer and seller, or between the 
partnership and distributee partner, will generally establish the fair 
market value of the property described in this paragraph (c)(4).
    (5) For purposes of subtitle A of the Internal Revenue Code, the 
basis of any potential gain described in paragraph (c)(4) of this 
section is zero.
    (6)(i) If (at the time of any transaction referred to in paragraph 
(c)(4) of this section) a partnership holds property described in 
paragraph (c)(4) of this section and if--
    (A) A partner had a special basis adjustment under section 743(b) in 
respect of the property;
    (B) The basis under section 732 of the property if distributed to 
the partner would reflect a special basis adjustment under section 
732(d); or
    (C) On the date a partner acquired a partnership interest by way of 
a sale or exchange (or upon the death of another partner) the 
partnership owned the property and an election under section 754 was in 
effect with respect to the partnership, the partner's share of any 
potential gain described in paragraph (c)(4) of this section is 
determined under paragraph (c)(6)(ii) of this section.
    (ii) The partner's share of the potential gain described in 
paragraph (c)(4) of this section in respect of the property to which 
this paragraph (c)(6)(ii) applies is that amount of gain that the 
partner would recognize under section 617(d)(1), 995(c), 1245(a), 
1248(a), 1250(a), 1251(c) (as in effect before the Tax Reform Act of 
1984), 1252(a), 1253(a), or 1254(a) (as the case may be) upon a sale

[[Page 463]]

of the property by the partnership, except that, for purposes of this 
paragraph (c)(6) the partner's share of such gain is determined in a 
manner that is consistent with the manner in which the partner's share 
of partnership property is determined; and the amount of a potential 
special basis adjustment under section 732(d) is treated as if it were 
the amount of a special basis adjustment under section 743(b). For 
example, in determining, for purposes of this paragraph (c)(6), the 
amount of gain that a partner would recognize under section 1245 upon a 
sale of partnership property, the items allocated under Sec. 1.1245-
1(e)(3)(ii) are allocated to the partner in the same manner as the 
partner's share of partnership property is determined. See Sec. 1.1250-
1(f) for rules similar to those contained in Sec. 1.1245-1(e)(3)(ii).
    (d) Inventory items which have substantially appreciated in value--
(1) Substantial appreciation. Partnership inventory items shall be 
considered to have appreciated substantially in value if, at the time of 
the sale or distribution, the total fair market value of all the 
inventory items of the partnership exceeds 120 percent of the aggregate 
adjusted basis for such property in the hands of the partnership 
(without regard to any special basis adjustment of any partner) and, in 
addition, exceeds 10 percent of the fair market value of all partnership 
property other than money. The terms ``inventory items which have 
appreciated substantially in value'' or ``substantially appreciated 
inventory items'' refer to the aggregate of all partnership inventory 
items. These terms do not refer to specific partnership inventory items 
or to specific groups of such items. For example, any distribution of 
inventory items by a partnership the inventory items of which as a whole 
are substantially appreciated in value shall be a distribution of 
substantially appreciated inventory items for the purposes of section 
751(b), even though the specific inventory items distributed may not be 
appreciated in value. Similarly, if the aggregate of partnership 
inventory items are not substantially appreciated in value, a 
distribution of specific inventory items, the value of which is more 
than 120 percent of their adjusted basis, will not constitute a 
distribution of substantially appreciated inventory items. For the 
purpose of this paragraph, the ``fair market value'' of inventory items 
has the same meaning as ``market'' value in the regulations under 
section 471, relating to general rule for inventories.
    (2) Inventory items. The term inventory items as used in subchapter 
K, chapter 1 of the Code, includes the following types of property:
    (i) Stock in trade of the partnership, or other property of a kind 
which would properly be included in the inventory of the partnership if 
on hand at the close of the taxable year, or property held by the 
partnership primarily for sale to customers in the ordinary course of 
its trade or business. See section 1221(1).
    (ii) Any other property of the partnership which, on sale or 
exchange by the partnership, would be considered property other than a 
capital asset and other than property described in section 1231. Thus, 
accounts receivable acquired in the ordinary course of business for 
services or from the sale of stock in trade constitute inventory items 
(see section 1221(4)), as do any unrealized receivables.
    (iii) Any other property retained by the partnership which, if held 
by the partner selling his partnership interest or receiving a 
distribution described in section 751(b), would be considered property 
described in subdivision (i) or (ii) of this subparagraph. Property 
actually distributed to the partner does not come within the provisions 
of section 751(d)(2)(C) and this subdivision.
    (e) Section 751 property and other property. For the purposes of 
this section, section 751 property means unrealized receivables or 
substantially appreciated inventory items, and other property means all 
property (including money) except section 751 property.
    (f) Effective date. Section 751 applies to gain or loss to a seller, 
distributee, or partnership in the case of a sale, exchange, or 
distribution occurring after March 9, 1954. For the purpose of applying 
this paragraph in the case of a taxable year beginning before January 1, 
1955, a partnership or a partner may elect to treat as applicable any 
other section of subchapter K, chapter 1 of

[[Page 464]]

the Code. Any such election shall be made by a statement submitted not 
later than the time prescribed by law for the filing of the return for 
such taxable year, or August 21, 1956, whichever date is later (but not 
later than 6 months after the time prescribed by law for the filing of 
the return for such year). See section 771(b)(3) and paragraph (b)(3) of 
Sec. 1.771-1. See also section 771(c) and paragraph (c) of Sec. 1.771-1.
    (g) Examples. Application of the provisions of section 751 may be 
illustrated by the following examples:

    Example 1. C buys B's interest in personal service partnership AB 
for $15,000, when the balance sheet of the firm (reflecting a cash 
receipts and disbursements method of accounting) is as follows:

                                 Assets                                 
------------------------------------------------------------------------
                                                   Adjusted             
                                                   basis per    Market  
                                                     books       value  
------------------------------------------------------------------------
Cash............................................      $3,000      $3,000
Loans receivable................................      10,000      10,000
Other assets....................................       7,000       7,000
Unrealized receivables..........................           0      12,000
                                                 -----------------------
    Total.......................................      20,000      32,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                   Per books     Value  
------------------------------------------------------------------------
Liabilities.....................................      $2,000      $2,000
Capital:                                                                
  A.............................................       9,000      15,000
  B.............................................       9,000      15,000
                                                 -----------------------
    Total.......................................      20,000      32,000
------------------------------------------------------------------------

Section 751(a) applies to the sale. The total amount realized by B is 
$16,000, consisting of the cash received, $15,000, plus $1,000, B's 
share of the partnership liabilities assumed by C. See section 752. B's 
undivided half interest in the partnership property includes a half-
interest in the partnership's unrealized receivables which are worth 
$12,000. Consequently, $6,000 of the $16,000 realized by B shall be 
considered received in exchange for B's interest in the partnership 
attributable to its unrealized receivables. The remaining $10,000 
realized by B is in exchange for a capital asset. B's basis for his 
partnership interest is $10,000 ($9,000, plus $1,000, B's share of 
partnership liabilities). No portion of this basis is attributable to 
B's share of the unrealized receivables of the partnership since such 
property has a zero basis in the hands of the partnership; therefore, B 
has a basis of zero for the unrealized receivables because the 
partnership basis for such receivables would have carried over to him 
under section 732 had they been distributed to him. The difference 
between the zero basis and the $6,000 B realized for the unrealized 
receivables is ordinary income to him. The entire $10,000 of B's basis 
is the basis for his interest in partnership property other than 
unrealized receivables and is applied against the remaining $10,000 
($16,000 minus $6,000) received from the sale of his interest. 
Therefore, B has no capital gain or loss. (If B's basis for his interest 
in partnership property, other than unrealized receivables, were $9,000, 
he would realize capital gain of $1,000. If his basis were $11,000, he 
would sustain a capital loss of $1,000).
    Example 2. (a) Facts. Partnership ABC makes a distribution to 
partner C in liquidation of his entire one-third interest in the 
partnership. At the time of the distribution, the balance sheet of the 
partnership, which uses the accrual method of accounting, is as follows:

                                 Assets                                 
------------------------------------------------------------------------
                                                   Adjusted             
                                                   basis per    Market  
                                                     books       value  
------------------------------------------------------------------------
Cash............................................     $15,000     $15,000
Accounts receivable.............................       9,000       9,000
Inventory.......................................      21,000      30,000
Depreciable property............................      42,000      48,000
Land............................................       9,000       9,000
                                                 -----------------------
    Total.......................................      96,000      11,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                   Per books     Value  
------------------------------------------------------------------------
Current liabilities.............................     $15,000     $15,000
Mortgage payable................................      21,000      21,000
Capital:                                                                
  A.............................................      20,000      25,000
  B.............................................      20,000      25,000

[[Page 465]]

                                                                        
  C.............................................      20,000      25,000
                                                 -----------------------
    Total.......................................      96,000     111,000
------------------------------------------------------------------------

The distribution received by C consists of $10,000 cash and depreciable 
property with a fair market value of $15,000 and an adjusted basis to 
the partnership of $15,000.
    (b) Presence of section 751 property. The partnership has no 
unrealized receivables, but the dual test provided in section 751(d)(1) 
must be applied to determine whether the inventory items of the 
partnership, in the aggregate, have appreciated substantially in value. 
The fair market value of all partnership inventory items, $39,000 
(inventory $30,000, and accounts receivable $9,000), exceeds 120 percent 
of the $30,000 adjusted basis of such items to the partnership. The fair 
market value of the inventory items, $39,000, also exceeds 10 percent of 
the fair market value of all partnership property other than money (10 
percent of $96,000 or $9,600). Therefore, the partnership inventory 
items have substantially appreciated in value.
    (c) The properties exchanged. Since C's entire partnership interest 
is to be liquidated, the provisions of section 736 are applicable. No 
part of the payment, however, is considered as a distributive share or 
as a guaranteed payment under section 736(a) because the entire payment 
is made for C's interest in partnership property. Therefore, the entire 
payment is for an interest in partnership property under section 736(b), 
and, to the extent applicable, subject to the rules of section 751. In 
the distribution, C received his share of cash ($5,000) and $15,000 in 
depreciable property ($1,000 less than his $16,000 share). In addition, 
he received other partnership property ($5,000 cash and $12,000 
liabilities assumed, treated as money distributed under section 752(b)) 
in exchange for his interest in accounts receivable ($3,000), inventory 
($10,000), land ($3,000), and the balance of his interest in depreciable 
property ($1,000). Section 751(b) applies only to the extent of the 
exchange of other property for section 751 property (i.e., inventory 
items, which include trade accounts receivable). The section 751 
property exchanged has a fair market value of $13,000 ($3,000 in 
accounts receivable and $10,000 in inventory). Thus, $13,000 of the 
total amount C received is considered as received for the sale of 
section 751 property.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. C's share of the inventory 
items is treated as if he received them in a current distribution, and 
his basis for such items is $10,000 ($7,000 for inventory and $3,000 for 
accounts receivable) as determined under paragraph (b)(3)(iii) of this 
section. Then C is considered as having sold his share of inventory 
items to the partnership for $13,000. Thus, on the sale of his share of 
inventory items, C realizes $3,000 of ordinary income.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution, C's basis for his partnership interest was $32,000 
($20,000 plus $12,000, his share of partnership liabilities). See 
section 752(a). This basis is reduced by $10,000, the basis attributed 
to the section 751 property treated as distributed to C and sold by him 
to the partnership. Thus, C has a basis of $22,000 for the remainder of 
his partnership interest. The total distribution to C was $37,000 
($22,000 in cash and liabilities assumed, and $15,000 in depreciable 
property). Since C received no more than his share of the depreciable 
property, none of the depreciable property constitutes proceeds of the 
sale under section 751(b). C did receive more than his share of money. 
Therefore, the sale proceeds, treated separately in subparagraph (1) of 
this paragraph of this example, must consist of money and therefore must 
be deducted from the money distribution. Consequently, in liquidation of 
the balance of C's interest, he receives depreciable property and $9,000 
in money ($22,000 less $13,000). Therefore, no gain or loss is 
recognized to C on the distribution. Under section 732(b), C's basis for 
the depreciable property is $13,000 (the remaining basis of his 
partnership interest, $22,000, reduced by $9,000, the money received in 
the distribution).
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has no ordinary income on the distribution 
since it did not give up any section 751 property in the exchange. Of 
the $22,000 money distributed (in cash and the assumption of C's share 
of liabilities), $13,000 was paid to acquire C's interest in inventory 
($10,000 fair market value) and in accounts receivable ($3,000). Since 
under section 751(b) the partnership is treated as buying these 
properties, it has a new cost basis for the inventory and accounts 
receivable acquired from C. Its basis for C's share of inventory and 
accounts receivable is $13,000, the amount which the partnership is 
considered as having paid C in the exchange. Since the partnership is 
treated as having distributed C's share of inventory and accounts 
receivable to him, the partnership must decrease its basis for inventory 
and accounts receivable ($30,000) by $10,000, the basis of C's share 
treated as distributed to him, and then increase the basis for inventory 
and accounts receivable by $13,000 to reflect the purchase

[[Page 466]]

prices of the items acquired. Thus, the basis of the partnership 
inventory is increased from $21,000 to $24,000 in the transaction. (Note 
that the basis of property acquired in a section 751(b) exchange is 
determined under section 1012 without regard to any elections of the 
partnership. See paragraph (e) of Sec. 1.732-1.) Further, the 
partnership realizes no capital gain or loss on the portion of the 
distribution treated as a sale under section 751(b) since, to acquire 
C's interest in the inventory and accounts receivable, it gave up money 
and assumed C's share of liabilities.
    (2) The part of the distribution not under section 751(b). In the 
remainder of the distribution to C which was not in exchange for C's 
interest in section 751 property, C received only other property as 
follows: $15,000 in depreciable property (with a basis to the 
partnership of $15,000) and $9,000 in money ($22,000 less $13,000 
treated under subparagraph (1) of this paragraph of this example). Since 
this part of the distribution is not an exchange of section 751 property 
for other property, section 751(b) does not apply. Instead, the 
provisions which apply are sections 731 through 736, relating to 
distributions by a partnership. No gain or loss is recognized to the 
partnership on the distribution. (See section 731(b).) Further, the 
partnership makes no adjustment to the basis of remaining depreciable 
property unless an election under section 754 is in effect. (See section 
734(a).) Thus, the basis of the depreciable property before the 
distribution, $42,000, is reduced by the basis of the depreciable 
property distributed, $15,000, leaving a basis for the depreciable 
property in the partnership of $27,000. However, if an election under 
section 754 is in effect, the partnership must make the adjustment 
required under section 734(b) as follows: Since the adjusted basis of 
the distributed property to the partnership had been $15,000, and is 
only $13,000 in C's hands (see paragraph (d)(2) of this example), the 
partnership will increase the basis of the depreciable property 
remaining in the partnership by $2,000 (the excess of the adjusted basis 
to the partnership of the distributed depreciable property immediately 
before the distribution over its basis to the distributee). Whether or 
not an election under section 754 is in effect, the basis for each of 
the remaining partner's partnership interests will be $38,000 ($20,000 
original contribution, plus $12,000, each partner's original share of 
the liabilities, plus $6,000, the share of C's liabilities each 
assumed).
    (f) Partnership trial balance. A trial balance of the AB partnership 
after the distribution in liquidation of C's entire interest would 
reflect the results set forth in the schedule below. Column I shows the 
amounts to be reflected in the records if an election is in effect under 
section 754 with respect to an optional adjustment under section 734(b) 
to the basis of undistributed partnership property. Column II shows the 
amounts to be reflected in the records where an election under section 
754 is not in effect. Note that in column II, the total bases for the 
partnership assets do not equal the total of the bases for the 
partnership interests.
    Example 3. (a) Facts. Assume that the distribution to partner C in 
example 2 of this paragraph in liquidation of his entire interest in 
partnership ABC consists of $5,000 in cash and $20,000 worth of 
partnership inventory with a basis of $14,000.

------------------------------------------------------------------------
                                           I                  II        
                                 ---------------------------------------
                                   Sec.754, Election   Sec.754, Election
                                       in effect         not in effect  
                                 ---------------------------------------
                                              Fair                Fair  
                                    Basis    market     Basis    market 
                                              value               value 
------------------------------------------------------------------------
Cash............................    $5,000    $5,000    $5,000    $5,000
Accounts receivable.............     9,000     9,000     9,000     9,000
Inventory.......................    24,000    30,000    24,000    30,000
Depreciable property............    29,000    33,000    27,000    33,000
Land............................     9,000     9,000     9,000     9,000
                                 ---------------------------------------
                                    76,000    86,000    74,000    86,000
                                 =======================================
Current liabilities.............    15,000    15,000    15,000    15,000
Mortgage........................    21,000    21,000    21,000    21,000
Capital:                                                                
    ............................    20,000    25,000    20,000    25,000
    ............................    20,000    25,000    20,000    25,000
                                 ---------------------------------------
                                    76,000    86,000    76,000    86,000
------------------------------------------------------------------------

    (b) Presence of section 751 property. For the same reason as stated 
in paragraph (b) of example 2, the partnership inventory items have 
substantially appreciated in value.
    (c) The properties exchanged. In the distribution, C received his 
share of cash ($5,000) and his share of appreciated inventory items 
($13,000). In addition, he received appreciated inventory with a fair 
market value of $7,000 (and with an adjusted basis to the partnership of 
$4,900) and $12,000 in money (liabilities assumed). C has relinquished 
his interest in $16,000 of depreciable property and $3,000 of land. 
Although C relinquished his interest in $3,000 of accounts receivable, 
such accounts receivable are inventory items and, therefore, that 
exchange was not an exchange of section 751 property for other property. 
Section 751(b) applies only to the extent of the exchange of other 
property for section 751 property (i.e., depreciable property or land 
for inventory items). Assume that the partners agree that the $7,000 of 
inventory in excess of C's share was received by him in exchange for 
$7,000 of depreciable property.
    (d) Distributee partner's tax consequences. C's tax consequence on 
the distributions are as follows:

[[Page 467]]

    (1) The section 751(b) sale or exchange. C is treated as if he had 
received his 7/16ths share of the depreciable property in a current 
distribution. His basis for that share is $6,125 (42,000/48,000 of 
$7,000), as determined under paragraph (b)(2)(iii) of this section. Then 
C is considered as having sold his 7/16ths share of depreciable property 
to the partnership for $7,000, realizing a gain of $875.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution, C's basis for his partnership interest was $32,000 
($20,000, plus $12,000, his share of partnership liabilities). See 
section 752(a). This basis is reduced by $6,125, the basis of property 
treated as distributed to C and sold by him to the partnership. Thus, C 
will have a basis of $25,875 for the remainder of his partnership 
interest. Of the $37,000 total distribution to C, $30,000 ($17,000 in 
money, including liabilities assumed, and $13,000 in inventory) is not 
within section 751(b). Under section 732(b), C's basis for the inventory 
with a fair market value of $13,000 (which had an adjusted basis to the 
partnership of $9,100) is limited to $8,875, the amount of the remaining 
basis for his partnership interest, $25,875, reduced by $17,000, the 
money received. Thus, C's total aggregate basis for the inventory 
received is $15,875 ($7,000 plus $8,875), and not its $14,000 basis in 
the hands of the partnership.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has $2,100 of ordinary income on the sale of 
the $7,000 of inventory which had a basis to the partnership of $4,900 
(21,000/30,000 of $7,000). This $7,000 of inventory was paid to acquire 
7/16ths of C's interest in the depreciable property. Since, under 
section 751(b), the partnership is treated as buying this property from 
C, it has a new cost basis for such property. Its basis for the 
depreciable property is $42,875 ($42,000 less $6,125, the basis of the 
7/16ths share considered as distributed to C, plus $7,000, the 
partnership purchase price for this share).
    (2) The part of the distribution not under section 751 (b). In the 
remainder of the distribution to C which was not a sale or exchange of 
section 751 property for other property, the partnership realizes no 
gain or loss. See section 731(b). Further, under section 734(a), the 
partnership makes no adjustment to the basis of the accounts receivable 
or the 9/16ths interest in depreciable property which C relinquished. 
However, if an election under section 754 is in effect, the partnership 
must make the adjustment required under section 734(b) since the 
adjusted basis to the partnership of the inventory distributed had been 
$9,100, and C's basis for such inventory after distribution is only 
$8,875. The basis of the inventory remaining in the partnership must be 
increased by $225. Whether or not an election under section 754 is in 
effect, the basis for each of the remaining partnership interests will 
be $39,050 ($20,000 original contribution, plus $12,000, each partner's 
original share of the liabilities, plus $6,000, the share of C's 
liabilities now assumed, plus $1,050, each partner's share of ordinary 
income realized by the partnership upon that part of the distribution 
treated as a sale or exchange).
    Example 4. (a) Facts. Assume the same facts as in example 3 of this 
paragraph, except that the partners did not identify the property which 
C relinquished in exchange for the $7,000 of inventory which he received 
in excess of his share.
    (b) Presence of section 751 property. For the same reasons stated in 
paragraph (b) of example 2 of this paragraph, the partnership inventory 
items have substantially appreciated in value.
    (c) The properties exchanged. The analysis stated in paragraph (c) 
of example 3 of this paragraph is the same in this example, except that, 
in the absence of a specific agreement among the partners as to the 
properties exchanged, C will be presumed to have sold to the partnership 
a proportionate amount of each property in which he relinquished an 
interest. Thus, in the absence of an agreement, C has received $7,000 of 
inventory in exchange for his release of 7/19ths of the depreciable 
property and 7/19ths of the land. ($7,000, fair market value of property 
released, over $19,000, the sum of the fair market values of C's 
interest in the land and C's interest in the depreciable property.)
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. C is treated as if he had 
received his 7/19ths shares of the depreciable property and land in a 
current distribution. His basis for those shares is $6,263 (51,000/
57,000 of $7,000, their fair market value), as determined under 
paragraph (b)(2)(iii) of this section. Then C is considered as having 
sold his 7/19ths shares of depreciable property and land to the 
partnership for $7,000, realizing a gain of $737.
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Before the 
distribution C's basis for his partnership interest was $32,000 ($20,000 
plus $12,000, his share of partnership liabilities). See section 752(a). 
This basis is reduced by $6,263, the bases of C's shares of depreciable 
property and land treated as distributed to him and sold by him to the 
partnership. Thus, C will have a basis of $25,737 for the remainder of 
his partnership interest. Of the total $37,000 distributed to C, $30,000 
($17,000 in money, including liabilities assumed, and $13,000 in 
inventory) is not within section 751(b). Under section 732(b), C's basis 
for the inventory

[[Page 468]]

(with a fair market value of $13,000 and an adjusted basis to the 
partnership of $9,100) is limited to $8,737, the amount of the remaining 
basis for his partnership interest ($25,737 less $17,000, money 
received. Thus, C's total aggregate basis for the inventory he received 
is $15,737 ($7,000 plus $8,737), and not the $14,000 basis it had in the 
hands of the partnership.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership consisting 
of the remaining members has $2,100 of ordinary income on the sale of 
$7,000 of inventory which had a basis to the partnership of $4,900 
(21,000/30,000 of $7,000). This $7,000 of inventory was paid to acquire 
7/19ths of C's interest in the depreciable property and land. Since, 
under section 751(b), the partnership is treated as buying this property 
from C, it has a new cost basis for such property. The bases of the 
depreciable property and land would be $42,737 and $9,000, respectively. 
The basis for the depreciable property is computed as follows: The 
common partnership basis of $42,000 is reduced by the $5,158 basis 
(42,000/48,000 of $5,895) for C's 7/19ths interest constructively 
distributed and increased by $5,895 (16,000/19,000 of $7,000), the part 
of the purchase price allocated to the depreciable property. The basis 
of the land would be computed in the same way. The $9,000 original 
partnership basis is reduced by $1,105 basis ($9,000/9,000 of $1,105) of 
land constructively distributed to C, and increased by $1,105 (3,000/
19,000 of $7,000), the portion of the purchase price allocated to the 
land.
    (2) The part of the distribution not under section 751(b). In the 
remainder of the distribution to C which was not a sale or exchange of 
section 751 property for other property, the partnership realizes no 
gain or loss. See section 731(b). Further, under section 734(a), the 
partnership makes no adjustment to the basis of the accounts receivable 
or the 12/19ths interests in depreciable property and land which C 
relinquished. However, if an election under section 754 is in effect, 
the partnership must make the adjustment required under section 734(b) 
since the adjusted basis to the partnership of the inventory distributed 
had been $9,100 and C's basis for such inventory after the distribution 
is only $8,737. The basis of the inventory remaining in the partnership 
must be increased by the difference of $363. Whether or not an election 
under section 754 is in effect, the basis for each of the remaining 
partnership interests will be $39,050 ($20,000 original contribution 
plus $12,000, each partner's original share of the liabilities, plus 
$6,000, the share of C's liabilities assumed, plus $1,050, each 
partner's share of ordinary income realized by the partnership upon the 
part of the distribution treated as a sale or exchange).
    Example 5. (a) Facts. Assume that partner C in example 2 of this 
paragraph agrees to reduce his interest in capital and profits from one-
third to one-fifth for a current distribution consisting of $5,000 in 
cash, and $7,500 of accounts receivable with a basis to the partnership 
of $7,500. At the same time, the total liabilities of the partnership 
are not reduced. Therefore, after the distribution, C's share of the 
partnership liabilities has been reduced by $4,800 from $12,000 (1/3 of 
$36,000) to $7,200 (1/5 of $36,000).
    (b) Presence of section 751 property. For the same reasons as stated 
in paragraph (b) of example 2 of this paragraph, the partnership 
inventory items have substantially appreciated in value.
    (c) The properties exchanged. C's interest in the fair market value 
of the partnership properties before and after the distribution can be 
illustrated by the following table:

----------------------------------------------------------------------------------------------------------------
                                  C's interest Fair Market Value            C received                          
                                 ----------------------------------------------------------------               
              Item                   One-third       One-fifth     Distribution    In excess of   C relinquished
                                      before           after         of share          share                    
----------------------------------------------------------------------------------------------------------------
Cash............................          $5,000          $2,000          $3,000          $2,000  ..............
Liabilities assumed.............        (12,000)         (7,200)  ..............           4,800  ..............
Inventory items:                                                                                                
  Accounts receivable...........           3,000             300           2,700           4,800  ..............
  Inventory.....................          10,000           6,000  ..............  ..............          $4,000
Depreciable property............          16,000           9,600  ..............  ..............           6,400
Land............................           3,000           1,800  ..............  ..............           1,200
                                 -------------------------------------------------------------------------------
    Total.......................          25,000          12,500           5,700          11,600          11,600
----------------------------------------------------------------------------------------------------------------


[[Page 469]]

Although C relinquished his interest in $4,000 of inventory and received 
$4,800 of accounts receivable, both items constitute section 751 
property and C has received only $800 of accounts receivable for $800 
worth of depreciable property or for an $800 undivided interest in land. 
In the absence of an agreement identifying the properties exchanged, it 
is presumed C received $800 for proportionate shares of his interests in 
both depreciable property and land. To the extent that inventory was 
exchanged for accounts receivable, or to the extent cash was distributed 
for the release of C's interest in the balance of the depreciable 
property and land, the transaction does not fall within section 751(b) 
and is a current distribution under section 732(a). Thus, the remaining 
$6,700 of accounts receivable are received in a current distribution.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distribution are as follows:
    (1) The section 751(b) sale or exchange. Assuming that the partners 
paid $800 worth of accounts receivable for $800 worth of depreciable 
property, C is treated as if he received the depreciable property in a 
current distribution, and his basis for the $800 worth of depreciable 
property is $700 (42,000/48,000 of $800, its fair market value), as 
determined under paragraph (b)(2)(iii) of this section. Then C is 
considered as having sold his $800 share of depreciable property to the 
partnership for $800. On the sale of the depreciable property, C 
realizes a gain of $100. If, on the other hand, the partners had agreed 
that C exchanged an $800 interest in the land for $800 worth of accounts 
receivable, C would realize no gain or loss, because under paragraph 
(b)(2)(iii) of this section his basis for the land sold would be $800. 
In the absence of an agreement, the basis for the depreciable property 
and land (which C is considered as having received in a current 
distribution and then sold back to the partnership) would be $716 
(51,000/57,000 of $800). In that case, on the sale of the balance of the 
$800 share of depreciable property and land, C would realize $84 of gain 
($800 less $716).
    (2) The part of the distribution not under section 751(b). Section 
751(b) does not apply to the balance of the distribution. Under section 
731, C does not realize either gain or loss on the balance of the 
distribution. The adjustments to the basis of C's interest are 
illustrated in the following table:

----------------------------------------------------------------------------------------------------------------
                                                      If accounts                                               
                                                  receivable received       If accounts         If there is no  
                                                    for depreciable     receivable received       agreement     
                                                        property              for land                          
----------------------------------------------------------------------------------------------------------------
Original basis for C's interest................         $32,000                $32,000              $32,000     
Less basis of property distributed prior to                                                                     
 sec. 751 (b) sale or exchange.................            -700                   -800                 -716     
                                                ----------------------------------------------------------------
                                                         31,300                 31,200               31,284     
Less money received in distribution............          -9,800                 -9,800               -9,800     
                                                ----------------------------------------------------------------
                                                         21,500                 21,400               21,484     
Less basis of property received in a current                                                                    
 distribution under sec. 732...................          -6,700                 -6,700               -6,700     
                                                ----------------------------------------------------------------
Resulting basis for C's interest...............          14,800                 14,700               14,784     
----------------------------------------------------------------------------------------------------------------

C's basis for the $1,500 worth of accounts receivable which he received 
in the distribution will be $7,500, composed of $800 for the portion 
purchased in the section 751(b) exchange, plus $6,700, the basis carried 
over under section 732(a) for the portion received in the current 
distribution.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. The partnership realizes no 
gain or loss in the section 751 sale or exchange because it had a basis 
of $800 for the accounts receivable for which it received $800 worth of 
other property. If the partnership agreed to purchase $800 worth of 
depreciable property, the partnership basis of depreciable property 
becomes $42,100 ($42,000 less $700 basis of property constructively 
distributed to C, plus $800, price of property purchased). If the 
partnership purchased land with the accounts receivable, there would be 
no change in the basis of the land to the partnership because the basis 
of land distributed was equal to its purchase price. If there were no 
agreement, the basis of the depreciable property and land would be 
$51,084 (depreciable property, $42,084 and land $9,000). The basis for 
the depreciable property is computed as follows: The common partnership 
basis of $42,000 is reduced by the $590 basis (42,000/48,000 of $674) 
for C's $674 interest constructively distributed, and increased by $674

[[Page 470]]

(6,400/7,600 of $800), the part of the purchase price allocated to the 
depreciable property. The basis of the land would be computed in the 
same way. The $9,000 original partnership basis is reduced by $126 basis 
(9,000/9,000 of $126) of the land constructively distributed to C, and 
increased by $126 (1,200/7,600 of $800), the portion of the purchase 
price allocated to the land.
    (2) The part of the distribution not under section 751(b). The 
partnership will realize no gain or loss in the balance of the 
distribution under section 731. Since the property in C's hands after 
the distribution will have the same basis it had in the partnership, the 
basis of partnership property remaining in the partnership after the 
distribution will not be adjusted (whether or not an election under 754 
is in effect).
    Example 6. (a) Facts. Partnership ABC distributes to partner C, in 
liquidation of his entire one-third interest in the partnership, a 
machine which is section 1245 property with a recomputed basis (as 
defined in section 1245(a)(2)) of $18,000. At the time of the 
distribution, the balance sheet of the partnership is as follows:

                                 Assets                                 
------------------------------------------------------------------------
                                                   Adjusted             
                                                   basis per    Market  
                                                     books       value  
------------------------------------------------------------------------
Cash............................................      $3,000      $3,000
Machine (section 1245 property).................       9,000      15,000
Land............................................      18,000      27,000
                                                 -----------------------
    Total.......................................      30,000      45,000
------------------------------------------------------------------------


                         Liabilities and Capital                        
------------------------------------------------------------------------
                                                   Per books     Value  
------------------------------------------------------------------------
Liabilities.....................................          $0          $0
Capital:                                                                
  A.............................................      10,000      15,000
  B.............................................      10,000      15,000
  C.............................................      10,000      15,000
                                                 -----------------------
    Total.......................................      30,000      45,000
------------------------------------------------------------------------

    (b) Presence of section 751 property. The section 1245 property is 
an unrealized receivable of the partnership to the extent of the 
potential section 1245 income in respect of the property. Since the fair 
market value of the property ($15,000) is lower than its recomputed 
basis ($18,000), the excess of the fair market value over its adjusted 
basis ($9,000), or $6,000, is the potential section 1245 income of the 
partnership in respect of the property. The partnership has no other 
section 751 property.
    (c) The properties exchanged. In the distribution C received his 
share of section 751 property (potential section 1245 income of $2,000, 
i.e., 1/3 of $6,000) and his share of section 1245 property (other than 
potential section 1245 income) with a fair market value of $3,000, i.e., 
1/3 of ($15,000 minus $6,000), and an adjusted basis of $3,000, i.e., 1/
3 of $9,000. In addition he received $4,000 of section 751 property 
(consisting of $4,000 ($6,000 minus $2,000) of potential section 1245 
income) and section 1245 property (other than potential section 1245 
income) with a fair market value of $6,000 ($9,000 minus $3,000) and an 
adjusted basis of $6,000 ($9,000 minus $3,000). C relinquished his 
interest in $1,000 of cash and $9,000 of land. Assume that the partners 
agree that the $4,000 of section 751 property in excess of C's share was 
received by him in exchange for $4,000 of land.
    (d) Distributee partner's tax consequences. C's tax consequences on 
the distributions are as follows:
    (1) The section 751(b) sale or exchange. C is treated as if he 
received in a current distribution 4/9ths of his share of the land with 
a basis of $2,667 (18,000/27,000 x $4,000). Then C is considered as 
having sold his 4/9ths share of the land to the partnership for $4,000, 
realizing a gain of $1,333. C's basis for the remainder of his 
partnership interest after the current distribution is $7,333, i.e., the 
basis of his partnership interest before the current distribution 
($10,000) minus the basis of the land treated as distributed to him 
($2,667).
    (2) The part of the distribution not under section 751(b). Of the 
$15,000 total distribution to C, $11,000 ($2,000 of potential section 
1245 income and $9,000 section 1245 property other than potential 
section 1245 income) is not within section 751(b). Under section 732(b) 
and (c), C's basis for his share of potential section 1245 income is 
zero (see paragraph (c)(5) of this section) and his basis for $9,000 of 
section 1245 property (other than potential section 1245 income) is 
$7,333, i.e., the amount of the remaining basis for his partnership 
interest ($7,333) reduced by the basis for his share of potential 
section 1245 income (zero). Thus C's total aggregate basis for the 
section 1245 property (fair market value of $15,000) distributed to him 
is $11,333 ($4,000 plus $7,333). For an illustration of the computation 
of his recomputed basis for the section 1245 property immediately after 
the distribution, see example 2 of paragraph (f)(3) of Sec. 1.1245-4.
    (e) Partnership's tax consequences. The tax consequences to the 
partnership on the distribution are as follows:
    (1) The section 751(b) sale or exchange. Upon the sale of $4,000 
potential section 1245 income, with a basis of zero, for 4/9ths of C's 
interest in the land, the partnership consisting of the remaining 
members has $4,000 ordinary income under sections 751(b) and 1245(a)(1). 
See section 1245(b)(3) and (6)(A). The partnership's new basis for the 
land is $19,333, i.e., $18,000, less the basis of the 4/9ths share 
considered as distributed to C ($2,667), plus the partnership purchase 
price for this share ($4,000).

[[Page 471]]

    (2) The part of the distribution not under section 751(b). The 
analysis under this subparagraph should be made in accordance with the 
principles illustrated in paragraph (e)(2) of examples 3, 4, and 5 of 
this paragraph.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6832, 30 FR 
8575, July 7, 1965; T.D. 7084, 36 FR 268, Jan. 8, 1971; T.D. 8586, 60 FR 
2500, Jan. 10, 1995]



Sec. 1.752-0  Table of Contents.

    This section lists the captions that appear in Secs. 1.752-1 through 
1.752-5.

           Sec. 1.752-1  Treatment of partnership liabilities.

    (a) Definitions.
    (1) Recourse liability defined.
    (2) Nonrecourse liability defined.
    (3) Related person.
    (b) Increase in partner's share of liabilities.
    (c) Decrease in partner's share of liabilities.
    (d) Assumption of liability.
    (e) Property subject to a liability.
    (f) Netting of increases and decreases in liabilities resulting from 
same transaction.
    (g) Example.
    (h) Sale or exchange of partnership interest.
    (i) Bifurcation of partnership liabilities.

         Sec. 1.752-2  Partner's share of recourse liabilities.

    (a) In general.
    (b) Obligation to make a payment.
    (1) In general.
    (2) Treatment upon deemed disposition.
    (3) Obligations recognized.
    (4) Contingent obligations.
    (5) Reimbursement rights.
    (6) Deemed satisfaction or obligation.
    (c) Partner or related person as lender.
    (1) In general.
    (2) Wrapped debt.
    (d) De minimis exceptions.
    (1) Partner as lender.
    (2) Partner as guarantor.
    (e) Special rule for nonrecourse liability with interest guaranteed 
by a partner.
    (1) In general.
    (2) Computation of present value.
    (3) Safe harbor.
    (4) De minimis exception.
    (f) Examples.
    (g) Time-value-of-money considerations.
    (1) In general.
    (2) Valuation of an obligation.
    (3) Satisfaction of obligation with partner's promissory note.
    (4) Example.
    (h) Partner providing property as security for partnership 
liability.
    (1) Direct pledge.
    (2) Indirect pledge.
    (3) Valuation.
    (4) Partner's promissory note.
    (i) Treatment of recourse liabilities in tiered partnerships.
    (j) Anti-abuse rules.
    (1) In general.
    (2) Arrangements tantamount to a guarantee.
    (3) Plan to circumvent or avoid the regulations.
    (4) Examples.

        Sec. 1.752-3  Partner's share of nonrecourse liabilities.

    (a) In general.
    (b) Examples.

                      Sec. 1.752-4  Special rules.

    (a) Tiered partnerships.
    (b) Related person definition.
    (1) In general.
    (2) Person related to more than one partner.
    (i) In general.
    (ii) Natural persons.
    (iii) Related partner exception.
    (iv) Special rule where entity structured to avoid related person 
status.
    (A) In general.
    (B) Ownership interest.
    (C) Example.
    (c) Limitation.
    (d) Time of determination.

           Sec. 1.752-5  Effective dates and transition rules.

    (a) In general.
    (b) Election.
    (1) In general.
    (2) Time and manner of election.
    (c) Effect of section 708(b)(1)(B) termination on determining date 
liabilities are incurred or assumed.

[T.D. 8380, 56 FR 66350, Dec. 23, 1991]



Sec. 1.752-1  Treatment of partnership liabilities.

    (a) Definitions. For purposes of section 752, the following 
definitions apply:
    (1) Recourse liability defined. A partnership liability is a 
recourse liability to the extent that any partner or related person 
bears the economic risk of loss for that liability under Sec. 1.752-2.
    (2) Nonrecourse liability defined. A partnership liability is a 
nonrecourse liability to the extent that no partner or related person 
bears the economic risk of loss for that liability under Sec. 1.752-2.
    (3) Related person. Related person means a person having a 
relationship to a partner that is described in Sec. 1.752-4(b).

[[Page 472]]

    (b) Increase in partner's share of liabilities. Any increase in a 
partner's share of partnership liabilities, or any increase in a 
partner's individual liabilities by reason of the partner's assumption 
of partnership liabilities, is treated as a contribution of money by 
that partner to the partnership.
    (c) Decrease in partner's share of liabilities. Any decrease in a 
partner's share of partnership liabilities, or any decrease in a 
partner's individual liabilities by reason of the partnership's 
assumption of the individual liabilities of the partner, is treated as a 
distribution of money by the partnership to that partner.
    (d) Assumption of liability. Except as otherwise provided in 
paragraph (e) of this section, a person is considered to assume a 
liability only to the extent that:
    (1) The assuming person is personally obligated to pay the 
liability; and
    (2) If a partner or related person assumes a partnership liability, 
the person to whom the liability is owed knows of the assumption and can 
directly enforce the partner's or related person's obligation for the 
liability, and no other partner or person that is a related person to 
another partner would bear the economic risk of loss for the liability 
immediately after the assumption.
    (e) Property subject to a liability. If property is contributed by a 
partner to the partnership or distributed by the partnership to a 
partner and the property is subject to a liability of the transferor, 
the transferee is treated as having assumed the liability, to the extent 
that the amount of the liability does not exceed the fair market value 
of the property at the time of the contribution or distribution.
    (f) Netting of increases and decreases in liabilities resulting from 
same transaction. If, as a result of a single transaction, a partner 
incurs both an increase in the partner's share of the partnership 
liabilities (or the partner's individual liabilities) and a decrease in 
the partner's share of the partnership liabilities (or the partner's 
individual liabilities), only the net decrease is treated as a 
distribution from the partnership and only the net increase is treated 
as a contribution of money to the partnership. Generally, the 
contribution to or distribution from a partnership of property subject 
to a liability or the termination of the partnership under section 
708(b) will require that increases and decreases in liabilities 
associated with the transaction be netted to determine if a partner will 
be deemed to have made a contribution or received a distribution as a 
result of the transaction.
    (g) Example. The following example illustrates the principles of 
paragraphs (b), (c), (e), and (f) of this section.

    Example. Property contributed subject to a liability; netting of 
increase and decrease in partner's share of liability. B contributes 
property with an adjusted basis of $1,000 to a general partnership in 
exchange for a one-third interest in the partnership. At the time of the 
contribution, the partnership does not have any liabilities outstanding 
and the property is subject to a recourse debt of $150 and has a fair 
market value in excess of $150. After the contribution, B remains 
personally liable to the creditor and none of the other partners bears 
any of the economic risk of loss for the liability under state law or 
otherwise. Under paragraph (e) of this section, the partnership is 
treated as having assumed the $150 liability. As a result, B's 
individual liabilities decrease by $150. At the same time, however, B's 
share of liabilities of the partnership increases by $150. Only the net 
increase or decrease in B's share of the liabilities of the partnership 
and B's individual liabilities is taken into account in applying section 
752. Because there is no net change, B is not treated as having 
contributed money to the partnership or as having received a 
distribution of money from the partnership under paragraph (b) or (c) of 
this section. Therefore B's basis for B's partnership interest is $1,000 
(B's basis for the contributed property).

    (h) Sale or exchange of a partnership interest. If a partnership 
interest is sold or exchanged, the reduction in the transferor partner's 
share of partnership liabilities is treated as an amount realized under 
section 1001 and the regulations thereunder. For example, if a partner 
sells an interest in a partnership for $750 cash and transfers to the 
purchaser the partner's share of partnership liabilities in the amount 
of $250, the seller realizes $1,000 on the transaction.
    (i) Bifurcation of partnership liabilities. If one or more partners 
bears the economic risk of loss as to part, but not

[[Page 473]]

all, of a partnership liability represented by a single contractual 
obligation, that liability is treated as two or more separate 
liabilities for purposes of section 752. The portion of the liability as 
to which one or more partners bear the economic risk of loss is a 
recourse liability and the remainder of the liability, if any, is a 
nonrecourse liability.

[T.D. 8380, 56 FR 66351, Dec. 23, 1991]



Sec. 1.752-2  Partner's share of resource liabilities.

    (a) In general. A partner's share of a recourse partnership 
liability equals the portion of that liability, if any, for which the 
partner or related person bears the economic risk of loss. The 
determination of the extent to which a partner bears the economic risk 
of loss for a partnership liability is made under the rules in 
paragraphs (b) through (j) of this section.
    (b) Obligation to make a payment. (1) In general. Except as 
otherwise provided in this section, a partner bears the economic risk of 
loss for a partnership liability to the extent that, if the partnership 
constructively liquidated, the partner or related person would be 
obligated to make a payment to any person (or a contribution to the 
partnership) because that liability becomes due and payable and the 
partner or related person would not be entitled to reimbursement from 
another partner or person that is a related person to another partner. 
Upon a constructive liquidation, all of the following events are deemed 
to occur simultaneously:
    (i) All of the partnership's liabilities become payable in full;
    (ii) With the exception of property contributed to secure a 
partnership liability (see Sec. 1.752-2(h)(2)), all of the partnership's 
assets, including cash, have a value of zero;
    (iii) The partnership disposes of all of its property in a fully 
taxable transaction for no consideration (except relief from liabilities 
for which the creditors's right to repayment is limited solely to one or 
more assets of the partnership);
    (iv) All items of income, gain, loss, or deduction are allocated 
among the partners; and
    (v) The partnership liquidates.
    (2) Treatment upon deemed disposition. For purposes of paragraph 
(b)(1) of this section, gain or loss on the deemed disposition of the 
partnership's assets is computed in accordance with the following:
    (i) If the creditor's right to repayment of a partnership liability 
is limited solely to one or more assets of the partnership, gain or loss 
is recognized in an amount equal to the difference between the amount of 
the liability that is extinguished by the deemed disposition and the tax 
basis (or book value to the extent section 704(c) or Sec. 1.704-
1(b)(4)(i) applies) in those assets.
    (ii) A loss is recognized equal to the remaining tax basis (or book 
value to the extent section 704(c) or Sec. 1.704-1(b)(4)(i) applies) of 
all the partnership's assets not taken into account in paragraph 
(b)(2)(i) of this section.
    (3) Obligations recognized. The determination of the extent to which 
a partner or related person has an obligation to make a payment under 
paragraph (b)(1) of this section is based on the facts and circumstances 
at the time of the determination. All statutory and contractual 
obligations relating to the partnership liability are taken into account 
for purposes of applying this section, including:
    (i) Contractual obligations outside the partnership agreement such 
as guarantees, indemnifications, reimbursement agreements, and other 
obligations running directly to creditors or to other partners, or to 
the partnership;
    (ii) Obligations to the partnership that are imposed by the 
partnership agreement, including the obligation to make a capital 
contribution and to restore a deficit capital account upon liquidation 
of the partnership; and
    (iii) Payment obligations (whether in the form of direct remittances 
to another partner or a contribution to the partnership) imposed by 
state law, including the governing state partnership statute.

To the extent that the obligation of a partner to make a payment with 
respect to a partnership liability is not recognized under this 
paragraph (b)(3), paragraph (b) of this section is applied as if the 
obligation did not exist.

[[Page 474]]

    (4) Contingent obligations. A payment obligation is disregarded if, 
taking into account all the facts and circumstances, the obligation is 
subject to contingencies that make it unlikely that the obligation will 
ever be discharged. If a payment obligation would arise at a future time 
after the occurrence of an event that is not determinable with 
reasonable certainty, the obligation is ignored until the event occurs.
    (5) Reimbursement rights. A partner's or related person's obligation 
to make a payment with respect to a partnership liability is reduced to 
the extent that the partner or related person is entitled to 
reimbursement from another partner or a person who is a related person 
to another partner.
    (6) Deemed satisfaction of obligation. For purposes of determining 
the extent to which a partner or related person has a payment obligation 
and the economic risk of loss, it is assumed that all partners and 
related persons who have obligations to make payments actually perform 
those obligations, irrespective of their actual net worth, unless the 
facts and circumstances indicate a plan to circumvent or avoid the 
obligation. See Sec. 1.752-2(j).
    (c) Partner or related person as lender--(1) In general. A partner 
bears the economic risk of loss for a partnership liability to the 
extent that the partner or a related person makes (or acquires an 
interest in) a nonrecourse loan to the partnership and the economic risk 
of loss for the liability is not borne by another partner.
    (2) Wrapped debt. If a partnership liability is owed to a partner or 
related person and that liability includes (i.e.,  is ``wrapped'' 
around) a nonrecourse obligation encumbering partnership property that 
is owed to another person, the partnership liability will be treated as 
two separate liabilities. The portion of the partnership liability 
corresponding to the wrapped debt is treated as a liability owed to 
another person.
    (d) De minimis exceptions--(1) Partner as lender. The general rule 
contained in paragraph (c)(1) of this section does not apply if a 
partner or related person whose interest (directly or indirectly through 
one or more partnerships including the interest of any related person) 
in each item of partnership income, gain, loss, deduction, or credit for 
every taxable year that the partner is a partner in the partnership is 
10 percent or less, makes a loan to the partnership which constitutes 
qualified nonrecourse financing within the meaning of section 465(b)(6) 
(determined without regard to the type of activity financed).
    (2) Partner as guarantor. The general rule contained in paragraph 
(b)(1) of this section does not apply if a partner or related person 
whose interest (directly or indirectly through one or more partnerships 
including the interest of any related person) in each item of 
partnership income, gain, loss, deduction, or credit for every taxable 
year that the partner is a partner in the partnership is 10 percent or 
less, guarantees a loan that would otherwise be a nonrecourse loan of 
the partnership and which would constitute qualified nonrecourse 
financing within the meaning of section 465(b)(6) (without regard to the 
type of activity financed) if the guarantor had made the loan to the 
partnership.
    (e) Special rule for nonrecourse liability with interest guaranteed 
by a partner--(1) In general. For purposes of this section, if one or 
more partners or related persons have guaranteed the payment of more 
than 25 percent of the total interest that will accrue on a partnership 
nonrecourse liability over its remaining term, and it is reasonable to 
expect that the guarantor will be required to pay substantially all of 
the guaranteed future interest if the partnership fails to do so, then 
the liability is treated as two separate partnership liabilities. If 
this rule applies, the partner or related person that has guaranteed the 
payment of interest is treated as bearing the economic risk of loss for 
the partnership liability to the extent of the present value of the 
guaranteed future interest payments. The remainder of the stated 
principal amount of the partnership liability constitutes a nonrecourse 
liability. Generally, in applying this rule, it is reasonable to expect 
that the guarantor will be required to pay substantially all of the 
guaranteed future interest if, upon a default in payment by the 
partnership, the lender

[[Page 475]]

can enforce the interest guaranty without foreclosing on the property 
and thereby extinguishing the underlying debt. The guarantee of interest 
rule continues to apply even after the point at which the amount of 
guaranteed interest that will accrue is less than 25 percent of the 
total interest that will accrue on the liability.
    (2) Computation of present value. The present value of the 
guaranteed future interest payments is computed using a discount rate 
equal to either the interest rate stated in the loan documents, or if 
interest is imputed under either section 483 or section 1274, the 
applicable federal rate, compounded semi-annually. The computation takes 
into account any payment of interest that the partner or related person 
may be required to make only to the extent that the interest will accrue 
economically (determined in accordance with section 446 and the 
regulations thereunder) after the date of the interest guarantee. If the 
loan document contains a variable rate of interest that is an interest 
rate based on current values of an objective interest index, the present 
value is computed on the assumption that the interest determined under 
the objective interest index on the date of the computation will remain 
constant over the term of the loan. The term ``objective interest 
index'' has the meaning given to it in section 1275 and the regulations 
thereunder (relating to variable rate debt instruments). Examples of an 
objective interest index include the prime rate of a designated 
financial institution, LIBOR (London Interbank Offered Rate), and the 
applicable federal rate under section 1274(d).
    (3) Safe harbor. The general rule contained in paragraph (e)(1) of 
this section does not apply to a partnership nonrecourse liability if 
the guarantee of interest by the partner or related person is for a 
period not in excess of the lesser of five years or one-third of the 
term of the liability.
    (4) De minimis exception. The general rule contained in paragraph 
(e)(1) of this section does not apply if a partner or related person 
whose interest (directly or indirectly through one or more partnerships 
including the interest of any related person) in each item of 
partnership income, gain, loss, deduction, or credit for every taxable 
year that the partner is a partner in the partnership is 10 percent of 
less, guarantees the interest on a loan to that partnership which 
constitutes qualified nonrecourse financing within the meaning of 
section 465(b)(6) (determined without regard to the type of activity 
financed). An allocation of interest to the extent paid by the guarantor 
is not treated as a partnership item of deduction or loss subject to the 
10 percent or less rule.
    (f) Examples. The following examples illustrate the principles of 
paragraphs (a) through (e) of this section.

    Example 1. Determining when a partner bears the economic risk of 
loss. A and B form a general partnership with each contributing $100 in 
cash. The partnership purchases an office building on leased land for 
$1,000 from an unrelated seller, paying $200 in cash and executing a 
note to the seller for the balance of $800. The note is a general 
obligation of the partnership, i.e., no partner has been relieved from 
personal liability. The partnership agreement provides that all items 
are allocated equally except that tax losses are specially allocated 90% 
to A and 10% to B and that capital accounts will be maintained in 
accordance with the regulations under section 704(b), including a 
deficit capital account restoration obligation on liquidation. In a 
constructive liquidation, the $800 liability becomes due and payable. 
All of the partnership's assets, including the building, are deemed to 
be worthless. The building is deemed sold for a value of zero. Capital 
accounts are adjusted to reflect the loss on the hypothetical 
disposition, as follows:

------------------------------------------------------------------------
                                                     A            B     
------------------------------------------------------------------------
Initial contribution..........................       $100         $100  
Loss on hypothetical sale.....................       (900)        (100) 
                                               -------------------------
                                                    ($800)          $0  
------------------------------------------------------------------------

Other than the partners' obligation to fund negative capital accounts on 
liquidation, there are no other contractual or statutory payment 
obligations existing between the partners, the partnership and the 
lender. Therefore, $800 of the partnership liability is classified as a 
recourse liability because one or more partners bears the economic risk 
of loss for non-payment. B has no share of the $800 liability since the 
constructive liquidation produces no payment obligation for B. A's share 
of the partnership liability is $800 because A would have an obligation 
in that amount to make a contribution to the partnership.
    Example 2. Recourse liability; deficit restoration obligation. C and 
D each contribute $500

[[Page 476]]

in cash to the capital of a new general partnership, CD. CD purchases 
property from an unrelated seller for $1,000 in cash and a $9,000 
mortgage note. The note is a general obligation of the partnership, 
i.e., no partner has been relieved from personal liability. The 
partnership agreement provides that profits and losses are to be divided 
40% to C and 60% to D. C and D are required to make up any deficit in 
their capital accounts. In a constructive liquidation, all partnership 
assets are deemed to become worthless and all partnership liabilities 
become due and payable in full. The partnership is deemed to dispose of 
all its assets in a fully taxable transaction for no consideration. 
Capital accounts are adjusted to reflect the loss on the hypothetical 
disposition, as follows:

------------------------------------------------------------------------
                                                     C            D     
------------------------------------------------------------------------
Initial contribution..........................       $500         $500  
                                               -------------------------
Loss on hypothetical sale.....................     (4,000)      (6,000) 
                                                  ($3,500)     ($5,500) 
------------------------------------------------------------------------

C's capital account reflects a deficit that C would have to make up to 
$3,500 and D's capital account reflects a deficit that D would have to 
make up of $5,500. Therefore, the $9,000 mortgage note is a recourse 
liability because one or more partners bear the economic risk of loss 
for the liability. C's share of the recourse liability is $3,500 and D's 
share is $5,500.
    Example 3. Guarantee by limited partner; partner deemed to satisfy 
obligation. E and F form a limited partnership. E, the general partner, 
contributes $2,000 and F, the limited partner, contributes $8,000 in 
cash to the partnership. The partnership agreement allocates losses 20% 
to E and 80% to F until F's capital account is reduced to zero, after 
which all losses are allocated to E. The partnership purchases 
depreciable property for $25,000 using its $10,000 cash and a $15,000 
recourse loan from a bank. F guarantees payment of the $15,000 loan to 
the extent the loan remains unpaid after the bank has exhausted its 
remedies against the partnership. In a constructive liquidation, the 
$15,000 liability becomes due and payable. All of the partnership's 
assets, including the depreciable property, are deemed to be worthless. 
The depreciable property is deemed sold for a value of zero. Capital 
accounts are adjusted to reflect the loss on the hypothetical 
disposition, as follows:

------------------------------------------------------------------------
                                                     E            F     
------------------------------------------------------------------------
Initial contribution..........................     $2,000       $8,000  
Loss on hypothetical sale.....................    (17,000)      (8,000) 
                                               -------------------------
                                                 ($15,000)          $0  
------------------------------------------------------------------------

E, as a general partner, would be obligated by operation of law to make 
a net contribution to the partnership of $15,000. Because E is assumed 
to satisfy that obligation, it is also assumed that F would not have to 
satisfy F's guarantee. The $15,000 mortgage is treated as a recourse 
liability because one or more partners bear the economic risk of loss. 
E's share of the liability is $15,000, and F's share is zero. This would 
be so even if E's net worth at the time of the determination is less 
than $15,000, unless the facts and circumstances indicate a plan to 
circumvent or avoid E's obligation to contribute to the partnership.
    Example 4. Partner guarantee with right of subrogation. G, a limited 
partner in the GH partnership, guarantees a portion of a partnership 
liability. The liability is a general obligation of the partnership, 
i.e., no partner has been relieved from personal liability. If under 
state law G is subrogated to the rights of the lender, G would have the 
right to recover the amount G paid to the recourse lender from the 
general partner. Therefore, G does not bear the economic risk of loss 
for the partnership liability.
    Example 5. Bifurcation of partnership liability; guarantee of part 
of nonrecourse liability. A partnership borrows $10,000, secured by a 
mortgage on real property. The mortgage note contains an exoneration 
clause which provides that in the event of default, the holder's only 
remedy is to foreclose on the property. The holder may not look to any 
other partnership asset or to any partner to pay the liability. However, 
to induce the lender to make the loan, a partner guarantees payment of 
$200 of the loan principal. The exoneration clause does not apply to the 
partner's guarantee. If the partner paid pursuant to the guarantee, the 
partner would be subrogated to the rights of the lender with respect to 
$200 of the mortgage debt, but the partner is not otherwise entitled to 
reimbursement from the partnership or any partner. For purposes of 
section 752, $200 of the $10,000 mortgage liability is treated as a 
recourse liability of the partnership and $9,800 is treated as a 
nonrecourse liability of the partnership. The partner's share of the 
recourse liability of the partnership is $200.
    Example 6. Wrapped debt. I, an individual, purchases real estate 
from an unrelated seller for $10,000, paying $1,000 in cash and giving a 
$9,000 purchase mortgage note on which I has no personal liability and 
as to which the seller can look only to the property for satisfaction. 
At a time when the property is worth $15,000, I sells the property to a 
partnership in which I is a general partner. The partnership pays for 
the property with a partnership purchase money mortgage note of $15,000 
on which neither the partnership nor any partner (or person related to a 
partner) has personal liability. The $15,000 mortgage note is a wrapped 
debt that includes the

[[Page 477]]

$9,000 obligation to the original seller. The liability is a recourse 
liability to the extent of $6,000 because I is the creditor with respect 
to the loan and I bears the economic risk of loss for $6,000. I's share 
of the recourse liability is $6,000. The remaining $9,000 is treated as 
a partnership nonrecourse liability that is owed to the unrelated 
seller.
    Example 7. Guarantee of interest by partner treated as part recourse 
and part nonrecourse. On January 1, 1992, a partnership obtains a 
$4,000,000 loan secured by a shopping center owned by the partnership. 
Neither the partnership nor any partner has any personal liability under 
the loan documents for repayment of the stated principal amount. 
Interest accrues at a 15 percent annual rate and is payable on December 
31 of each year. The principal is payable in a lump sum on December 31, 
2006. A partner guarantees payment of 50 percent of each interest 
payment required by the loan. The guarantee can be enforced without 
first foreclosing on the property. When the partnership obtains the 
loan, the present value (discounted at 15 percent, compounded annually) 
of the future interest payments is $3,508,422, and of the future 
principal payment is $491,578. If tested on that date, the loan would be 
treated as a partnership liability of $1,754,211 ($3,508,422  x  .5) for 
which the guaranteeing partner bears the economic risk of loss and a 
partnership nonrecourse liability of $2,245,789 ($1,754,211 + $491,578).
    Example 8. Contingent obligation not recognized. J and K form a 
general partnership with cash contributions of $2,500 each. J and K 
share partnership profits and losses equally. The partnership purchases 
an apartment building for its $5,000 of cash and a $20,000 nonrecourse 
loan from a commercial bank. The nonrecourse loan is secured by a 
mortgage on the building. The loan documents provide that the 
partnership will be liable for the outstanding balance of the loan on a 
recourse basis to the extent of any decrease in the value of the 
apartment building resulting from the partnership's failure properly to 
maintain the property. There are no facts that establish with reasonable 
certainty the existence of any liability on the part of the partnership 
(and its partners) for damages resulting from the partnership's failure 
properly to maintain the building. Therefore, no partner bears the 
economic risk of loss, and the liability constitutes a nonrecourse 
liability. Under Sec. 1.752-3, J and K share this nonrecourse liability 
equally because they share all profits and losses equally.

    (g) Time-value-of-money considerations--(1) In general. The extent 
to which a partner or related person bears the economic risk of loss is 
determined by taking into account any delay in the time when a payment 
or contribution obligation with respect to a partnership liability is to 
be satisfied. If a payment obligation with respect to a partnership 
liability is not required to be satisfied within a reasonable time after 
the liability becomes due and payable, or if the obligation to make a 
contribution to the partnership is not required to be satisfied before 
the later of--
    (i) The end of the year in which the partner's interest is 
liquidated, or
    (ii) 90 days after the liquidation,

the obligation is recognized only to the extent of the value of the 
obligation.
    (2) Valuation of an obligation. The value of a payment or 
contribution obligation that is not required to be satisfied within the 
time period specified in paragraph (g)(1) of this section equals the 
entire principal balance of the obligation only if the obligation bears 
interest equal to or greater than the applicable federal rate under 
section 1274(d) at the time of valuation, commencing on--
    (i) In the case of a payment obligation, the date that the 
partnership liability to a creditor or other person to whom the 
obligation relates becomes due and payable, or
    (ii) In the case of a contribution obligation, the date of the 
liquidation of the partner's interest in the partnership.

If the obligation does not bear interest at a rate at least equal to the 
applicable federal rate at the time of valuation, the value of the 
obligation is discounted to the present value of all payments due from 
the partner or related person (i.e., the imputed principal amount 
computed under section 1274(b)). For purposes of making this present 
value determination, the partnership is deemed to have constructively 
liquidated as of the date on which the payment obligation is valued and 
the payment obligation is assumed to be a debt instrument subject to the 
rules of section 1274 (i.e., the debt instrument is treated as if it 
were issued for property at the time of the valuation).
    (3) Satisfaction of obligation with partner's promissory note. An 
obligation is not satisfied by the transfer to the obligee of a 
promissory note by a partner

[[Page 478]]

or related person unless the note is readily tradeable on an established 
securities market.
    (4) Example. The following example illustrates the principle of 
paragraph (g) of this section.

    Example. Value of obligation not required to be satisfied within 
specified time period. A, the general partner, and B, the limited 
partner, each contributes $10,000 to partnership AB. AB purchases 
property from an unrelated seller for $20,000 in cash and a $70,000 
recourse purchase money note. The partnership agreement provides that 
profits and losses are to be divided equally. A and B are required to 
make up any deficit in their capital accounts. While A is required to 
restore any deficit balance in A's capital account within 90 days after 
the date of liquidation of the partnership, B is not required to restore 
any deficit for two years following the date of liquidation. The deficit 
in B's capital account will not bear interest during that two-year 
period. In a constructive liquidation, all partnership assets are deemed 
to become worthless and all partnership liabilities become due and 
payable in full. The partnership is deemed to dispose of all its assets 
in a fully taxable transaction for no consideration. Capital accounts 
are adjusted to reflect the loss on the hypothetical disposition, as 
follows:

------------------------------------------------------------------------
                                                     A            B     
------------------------------------------------------------------------
Initial contribution..........................    $10,000      $10,000  
Loss on hypothetical sale.....................    (45,000)     (45,000) 
                                               -------------------------
                                                  (35,000)     (35,000) 
------------------------------------------------------------------------

A's and B's capital accounts each reflect deficits of $35,000. B's 
obligation to make a contribution pursuant to B's deficit restoration 
obligation is recognized only to the extent of the fair market value of 
that obligation at the time of the constructive liquidation because B is 
not required to satisfy that obligation by the later of the end of the 
partnership taxable year in which B's interest is liquidated or within 
90 days after the date of the liquidation. Because B's obligation does 
not bear interest, the fair market value is deemed to equal the imputed 
principal amount under section 1274(b). Under section 1274(b), the 
imputed principal amount of a debt instrument equals the present value 
of all payments due under the debt instrument. Assume the applicable 
federal rate with respect to B's obligation is 10 percent compounded 
semiannually. Using this discount rate, the present value of the $35,000 
payment that B would be required to make two years after the 
constructive liquidation to restore the deficit balance in B's capital 
account equals $28,795. To the extent that B's deficit restoration 
obligation is not recognized, it is assumed that B's obligation does not 
exist. Therefore, A, as the sole general partner, would be obligated by 
operation of law to contribute an additional $6,205 of capital to the 
partnership. Accordingly, under paragraph (g) of this section, B bears 
the economic risk of loss for $28,795 and A bears the economic risk of 
loss for $41,205 ($35,000 + $6,205).

    (h) Partner providing property as security for partnership 
liability--(1) Direct pledge. A partner is considered to bear the 
economic risk of loss for a partnership liability to the extent of the 
value of any the partner's or related person's separate property (other 
than a direct or indirect interest in the partnership) that is pledged 
as security for the partnership liability.
    (2) Indirect pledge. A partner is considered to bear the economic 
risk of loss for a partnership liability to the extent of the value of 
any property that the partner contributes to the partnership solely for 
the purpose of securing a partnership liability. Contributed property is 
not treated as contributed solely for the purpose of securing a 
partnership liability unless substantially all of the items of income, 
gain, loss, and deduction attributable to the contributed property are 
allocated to the contributing partner, and this allocation is generally 
greater than the partner's share of other significant items of 
partnership income, gain, loss, or deduction.

[[Page 479]]

    (3) Valuation. The extent to which a partner bears the economic risk 
of loss as a result of a direct pledge described in paragraph (h)(1) of 
this section or an indirect pledge described in paragraph (h)(2) of this 
section is limited to the fair market value of the property at the time 
of the pledge or contribution.
    (4) Partner's promissory note. For purposes of paragraph (h)(2) of 
this section, a promissory note of the partner or related person that is 
contributed to the partnership shall not be taken into account unless 
the note is readily tradeable on an established securities market.
    (i) Treatment of recourse liabilities in tiered partnerships. If a 
partnership (the ``upper-tier partnership'') owns (directly or 
indirectly through one or more partnerships) an interest in another 
partnership (the ``lower-tier partnership''), the liabilities of the 
lower-tier partnership are allocated to the upper-tier partnership in an 
amount equal to the sum of the following--
    (1) The amount of the economic risk of loss that the upper-tier 
partnership bears with respect to the liabilities; and
    (2) Any other amount of the liabilities with respect to which 
partners of the upper-tier partnership bear the economic risk of loss.
    (j) Anti-abuse rules--(1) In general. An obligation of a partner or 
related person to make a payment may be disregarded or treated as an 
obligation of another person for purposes of this section if facts and 
circumstances indicate that a principal purpose of the arrangement 
between the parties is to eliminate the partner's economic risk of loss 
with respect to that obligation or create the appearance of the partner 
or related person bearing the economic risk of loss when, in fact, the 
substance of the arrangement is otherwise. Circumstances with respect to 
which a payment obligation may be disregarded include, but are not 
limited to, the situations described in paragraphs (j)(2) and (j)(3) of 
this section.
    (2) Arrangements tantamount to a guarantee. Irrespective of the form 
of a contractual obligation, a partner is considered to bear the 
economic risk of loss with respect to a partnership liability, or a 
portion thereof, to the extent that:
    (i) The partner or related person undertakes one or more contractual 
obligations so that the partnership may obtain a loan;
    (ii) The contractual obligations of the partner or related person 
eliminate substantially all the risk to the lender that the partnership 
will not satisfy its obligations under the loan; and
    (iii) One of the principal purposes of using the contractual 
obligations is to attempt to permit partners (other than those who are 
directly or indirectly liable for the obligation) to include a portion 
of the loan in the basis of their partnership interests.

The partners are considered to bear the economic risk of loss for the 
liability in accordance with their relative economic burdens for the 
liability pursuant to the contractual obligations. For example, a lease 
between a partner and a partnership which is not on commercially 
reasonable terms may be tantamount to a guarantee by the partner of a 
partnership liability.
    (3) Plan to circumvent or avoid the obligation. An obligation of a 
partner to make a payment is not recognized if the facts and 
circumstances evidence a plan to circumvent or avoid the obligation.
    (4) Example. The following example illustrates the principle of 
paragraph (j)(3) of this section.

    Example. Plan to circumvent or avoid obligation. A and B form a 
general partnership. A, a corporation, contributes $20,000 and B 
contributes $80,000 to the partnership. A is obligated to restore any 
deficit in its partnership capital account. The partnership agreement 
allocates losses 20% to A and 80% to B until B's capital account is 
reduced to zero, after which all losses are allocated to A. The 
partnership purchases depreciable property for $250,000 using its 
$100,000 cash and a $150,000 recourse loan from a bank. B guarantees 
payment of the $150,000 loan to the extent the loan remains unpaid after 
the bank has exhausted its remedies against the partnership. A is a 
subsidiary, formed by a parent of a consolidated group, with capital 
limited to $20,000 to allow the consolidated group to enjoy the tax 
losses generated by the property while at the same time limiting its 
monetary exposure for such losses. These facts, when considered together 
with B's guarantee, indicate a plan to circumvent or avoid A's 
obligation to contribute to the partnership. The rules of section 752 
must be applied as if A's obligation to contribute did

[[Page 480]]

not exist. Accordingly, the $150,000 liability is a recourse liability 
that is allocated entirely to B.

[T.D. 8380, 56 FR 66351, Dec. 23, 1991; 57 FR 4913, Feb. 10, 1992; 57 FR 
5054, Feb. 12, 1992; 57 FR 5511, Feb. 14, 1992]



Sec. 1.752-3  Partner's share of nonrecourse liabilities.

    (a) In general. A partner's share of the nonrecourse liabilities of 
a partnership equals the sum of paragraphs (a)(1) through (a)(3) of this 
section as follows--
    (1) The partner's share of partnership minimum gain determined in 
accordance with the rules of section 704(b) and the regulations 
thereunder;
    (2) The amount of any taxable gain that would be allocated to the 
partner under section 704(c) (or in the same manner as section 704(c) in 
connection with a revaluation of partnership property) if the 
partnership disposed of (in a taxable transaction) all partnership 
property subject to one or more nonrecourse liabilities of the 
partnership in full satisfaction of the liabilities and for no other 
consideration; and
    (3) The partner's share of the excess nonrecourse liabilities (those 
not allocated under paragraphs (a)(1) and (a)(2) of this section) of the 
partnership as determined in accordance with the partner's share of 
partnership profits. The partner's interest in partnership profits is 
determined by taking into account all facts and circumstances relating 
to the economic arrangement of the partners. The partnership agreement 
may specify the partners' interests in partnership profits for purposes 
of allocating excess nonrecourse liabilities provided the interests so 
specified are reasonably consistent with allocations (that have 
substantial economic effect under the section 704(b) regulations) of 
some other significant item of partnership income or gain. 
Alternatively, excess nonrecourse liabilities may be allocated among the 
partners in accordance with the manner in which it is reasonably 
expected that the deductions attributable to those nonrecourse 
liabilities will be allocated. Excess nonrecourse liabilities are not 
required to be allocated under the same method each year.
    (b) Examples. The following examples illustrate the principles of 
paragraph (a) of this section.

    Example 1. Partner's share of nonrecourse liabilities. The AB 
partnership purchases depreciable property for a $1,000 purchase money 
note that is nonrecourse liability under the rules of this section. 
Assume that this is the only nonrecourse liability of the partnership, 
and that no principal payments are due on the purchase money note for a 
year. The partnership agreement provides that all items of income, gain, 
loss, and deduction are allocated equally. Immediately after purchasing 
the depreciable property, the partners share the nonrecourse liability 
equally because they have equal interests in partnership profits. A and 
B are each treated as if they contributed $500 to the partnership to 
reflect each partner's increase in his or her share of partnership 
liabilities (from $0 to $500). The minimum gain with respect to an item 
of partnership property subject to a nonrecourse liability equals the 
amount of gain that would be recognized if the partnership disposed of 
the property in full satisfaction of the nonrecourse liability and for 
no other consideration. Therefore, if the partnership claims a 
depreciation deduction of $200 for the depreciable property for the year 
it acquires that property, partnership minimum gain for the year will 
increase by $200 (the excess of the $1,000 nonrecourse liability over 
the $800 adjusted tax basis of the property). See section 704(b) and the 
regulations thereunder. A and B each have a $100 share of partnership 
minimum gain at the end of that year because the depreciation deduction 
is treated as a nonrecourse deduction. See section 704(b) and the 
regulation thereunder. Accordingly, at the end of that year, A and B are 
allocated $100 each of the nonrecourse liability to match their shares 
of partnership minimum gain. The remaining $800 of the nonrecourse 
liability will be allocated equally between A and B ($400 each).
    Example 2. Excess nonrecourse liabilities allocated consistently 
with reasonably expected deductions. The facts are the same as in 
Example 1 except that the partnership agreement provides that 
depreciation deductions will be allocated to A. The partners agree to 
allocate excess nonrecourse liabilities in accordance with the manner in 
which it is reasonably expected that the deductions attributable to 
those nonrecourse liabilities will be allocated. Assuming that the 
allocation of all of the depreciation deductions to A is valid under 
section 704(b), immediately after purchasing the depreciable property, 
A's share of the nonrecourse liability is $1,000. Accordingly, A is 
treated as if A contributed $1,000 to the partnership.

[T.D. 8380, 56 FR 66355, Dec. 23, 1991]

[[Page 481]]



Sec. 1.752-4  Special rules.

    (a) Tiered partnerships. An upper-tier partnership's share of the 
liabilities of a lower-tier partnership (other than any liability of the 
lower-tier partnership that is owed to the upper-tier partnership) is 
treated as a liability of the upper-tier partnership for purposes of 
applying section 752 and the regulations thereunder to the partners of 
the upper-tier partnership.
    (b) Related person definition--(1) In general. A person is related 
to a partner if the person and the partner bear a relationship to each 
other that is specified in section 267(b) or 707(b)(1), subject to the 
following modifications:
    (i) Substitute ``80 percent or more'' for ``more than 50 percent'' 
each place it appears in those sections;
    (ii) A person's family is determined by excluding brothers and 
sisters; and
    (iii) Disregard sections 267(e)(1) and 267(f)(1)(A).
    (2) Person related to more than one partner--(i) In general. If, in 
applying the related person rules in paragraph (b)(1) of this section, a 
person is related to more than one partner, paragraph (b)(1) of this 
section is applied by treating the person as related only to the partner 
with whom there is the highest percentage of related ownership. If two 
or more partners have the same percentage of related ownership and no 
other partner has a greater percentage, the liability is allocated 
equally among the partners having the equal percentages of related 
ownership.
    (ii) Natural persons. For purposes of determining the percentage of 
related ownership between a person and a partner, natural persons who 
are related by virtue of being members of the same family are treated as 
having a percentage relationship of 100 percent with respect to each 
other.
    (iii) Related partner exception. Notwithstanding paragraph (b)(1) of 
this section (which defines related person), persons owning interests 
directly or indirectly in the same partnership are not treated as 
related persons for purposes of determining the economic risk of loss 
borne by each of them for the liabilities of the partnership. This 
paragraph (iii) does not apply when determining a partner's interest 
under the de minimis rules in Secs. 1.752-2 (d) and (e).
    (iv) Special rule where entity structured to avoid related person 
status--(A) In general. If--
    (1) A partnership liability is owed to or guaranteed by another 
entity that is a partnership, an S corporation, a C corporation, or a 
trust;
    (2) A partner or related person owns (directly or indirectly) a 20 
percent or more ownership interest in the other entity; and
    (3) A principal purpose of having the other entity act as a lender 
or guarantor of the liability was to avoid the determination that the 
partner that owns the interest bears the economic risk of loss for 
federal income tax purposes for all or part of the liability;

then the partner is treated as holding the other entity's interest as a 
creditor or guarantor to the extent of the partner's or related person's 
ownership interest in the entity.
    (B) Ownership interest. For purposes of paragraph (b)(2)(iv)(A) of 
this section, a person's ownership interest in:
    (1) A partnership equals the partner's highest percentage interest 
in any item of partnership loss or deduction for any taxable year;
    (2) An S corporation equals the percentage of the outstanding stock 
in the S corporation owned by the shareholder;
    (3) A C corporation equals the percentage of the fair market value 
of the issued and outstanding stock owned by the shareholder; and
    (4) A trust equals the percentage of the actuarial interests owned 
by the beneficial owner of the trust.

    (C) Example. Entity structured to avoid related person status. A, B, 
and C form a general partnership, ABC. A, B, and C are equal partners, 
each contributing $1,000 to the partnership. A and B want to loan money 
to ABC and have the loan treated as nonrecourse for purposes of section 
752. A and B form partnership AB to which each contributes $50,000. A 
and B share losses equally in partnership AB. Partnership AB loans 
partnership ABC $100,000 on a nonrecourse basis secured by the property 
ABC buys with the loan. Under these facts and circumstances, A and B 
bear the economic risk of loss with respect to the partnership liability 
equally based on their percentage interest in losses of partnership AB.

    (c) Limitation. The amount of an indebtedness is taken into account 
only

[[Page 482]]

once, even though a partner (in addition to the partner's liability for 
the indebtedness as a partner) may be separately liable therefor in a 
capacity other than as a partner.
    (d) Time of determination. A partner's share of partnership 
liabilities must be determined whenever the determination is necessary 
in order to determine the tax liability of the partner or any other 
person. See Sec. 1.705-1(a) for rules regarding when the adjusted basis 
of a partner's interest in the partnership must be determined.

[T.D. 8380, 56 FR 66356, Dec. 23, 1991]



Sec. 1.752-5  Effective dates and transition rules.

    (a) In general. Unless a partnership makes an election under 
paragraph (b)(1) of this section to apply the provisions of Secs. 1.752-
1 through 1.752-4 earlier, Secs. 1.752-1 through 1.752-4 apply to any 
liability incurred or assumed by a partnership on or after December 28, 
1991, other than a liability incurred or assumed by the partnership 
pursuant to a written binding contract in effect prior to December 28, 
1991 and at all times thereafter. For liabilities incurred or assumed by 
a partnership prior to December 28, 1991 (or pursuant to a written 
binding contract in effect prior to December 28, 1991 and at all times 
thereafter), unless an election to apply these regulations has been 
made, see Secs. 1.752-0T to 1.752-4T, set forth in 26 CFR 1.752-0T 
through 1.752-4T as contained in 26 CFR edition revised April 1, 1991, 
(TD 8237, TD 8274, and TD 8355) and Sec. 1.752-1, set forth in 26 CFR 
1.752-1 as contained in 26 CFR edition revised April 1, 1988 (TD 6175 
and TD 6500).
    (b) Election--(1) In general. A partnership may elect to apply the 
provisions of Secs. 1.752-1 through 1.752-4 to all of its liabilities to 
which the provisions of those sections do not otherwise apply as of the 
beginning of the first taxable year of the partnership ending on or 
after December 28, 1991.
    (2) Time and manner of election. An election under this paragraph 
(b) is made by attaching a written statement to the partnership return 
for the first taxable year of the partnership ending on or after 
December 28, 1991. The written statement must include the name, address, 
and taxpayer identification number of the partnership making the 
statement and contain a declaration that an election is being made under 
this paragraph (b).
    (c) Effect of section 708(b)(1)(B) termination on determining date 
liabilities are incurred or assumed. For purposes of applying this 
section, a termination of the partnership under section 708(b)(1)(B) 
will not cause partnership liabilities incurred or assumed prior to the 
termination to be treated as incurred or assumed on the date of the 
termination.

[T.D. 8380, 56 FR 66356, Dec. 23, 1991]



Sec. 1.753-1   Partner receiving income in respect of decedent.

    (a) Income in respect of a decedent under section 736(a). All 
payments coming within the provisions of section 736(a) made by a 
partnership to the estate or other successor in interest of a deceased 
partner are considered income in respect of the decedent under section 
691. The estate or other successor in interest of a deceased partner 
shall be considered to have received income in respect of a decedent to 
the extent that amounts are paid by a third person in exchange for 
rights to future payments from the partnership under section 736(a). 
When a partner who is receiving payments under section 736(a) dies, 
section 753 applies to any remaining payments under section 736(a) made 
to his estate or other successor in interest.
    (b) Other income in respect of a decedent. When a partner dies, the 
entire portion of the distributive share which is attributable to the 
period ending with the date of his death and which is taxable to his 
estate or other successor constitutes income in respect of a decedent 
under section 691. This rule applies even though that part of the 
distributive share for the period before death which the decedent 
withdrew is not included in the value of the decedent's partnership 
interest for estate tax purposes. See paragraph (c) (3) of Sec. 1.706-1.
    (c) Example. The provisions of this section may be illustrated by 
the following example:


[[Page 483]]


    Example. A and the decedent B were equal partners in a business 
having assets (other than money) worth $40,000 with an adjusted basis of 
$10,000. Certain partnership business was well advanced towards 
completion before B's death and, after B's death but before the end of 
the partnership year, payment of $10,000 was made to the partnership for 
such work. The partnership agreement provided that, upon the death of 
one of the partners, all partnership property, including unfinished 
work, would pass to the surviving partner, and that the surviving 
partner would pay the estate of the decedent the undrawn balance of his 
share of partnership earnings to the date of death, plus $10,000 in each 
of the three years after death. B's share of earnings to the date of his 
death was $4,000, of which he had withdrawn $3,000. B's distributive 
share of partnership income of $4,000 to the date of his death is income 
in respect of a decedent (although only the $1,000 undrawn at B's death 
will be reflected in the value of B's partnership interest on B's estate 
tax return). Assume that the value of B's interest in partnership 
property at the date of his death was $22,000, composed of the following 
items: B's one-half share of the assets of $40,000, plus $2,000, B's 
interest in partnership cash. It should be noted that B's $1,000 undrawn 
share of earnings to the date of his death is not a separate item but 
will be paid from partnership assets. Under the partnership agreement, A 
is to pay B's estate a total of $31,000. The difference of $9,000 
between the amount to be paid by A ($31,000) and the value of B's 
interest in partnership property ($22,000) comes within section 736(a) 
and, thus, also constitutes income in respect of a decedent. (However, 
the $17,000 difference between the $5,000 basis for B's share of the 
partnership property and its $22,000 value at the date of his death does 
not constitute income in respect of a decedent.) If, before the close of 
the partnership taxable year, A pays B's estate $11,000, of which they 
agree to allocate $3,000 as the payment under section 736(a), B's estate 
will include $7,000 in its gross income (B's $4,000 distributive share 
plus $3,000 payment under section 736(a)). In computing the deduction 
under section 691(c), this $7,000 will be considered as the value for 
estate tax purposes of such income in respect of a decedent, even though 
only $4,000 ($1,000 of distributive share not withdrawn, plus $3,000, 
payment under section 736(a)) of this amount can be identified on the 
estate tax return as part of the partnership interest.

    (d) Effective date. The provisions of section 753 apply only in the 
case of payments made with respect to decedents whose death occurred 
after December 31, 1954. See section 771(b)(4) and paragraph (b)(4) of 
Sec. 1.771-1.



Sec. 1.754-1   Time and manner of making election to adjust basis of partnership property.

    (a) In general. A partnership may adjust the basis of partnership 
property under sections 734(b) and 743(b) if it files an election in 
accordance with the rules set forth in paragraph (b) of this section. An 
election may not be filed to make the adjustments provided in either 
section 734(b) or section 743(b) alone, but such an election must apply 
to both sections. An election made under the provisions of this section 
shall apply to all property distributions and transfers of partnership 
interests taking place in the partnership taxable year for which the 
election is made and in all subsequent partnership taxable years unless 
the election is revoked pursuant to paragraph (c) of this section.
    (b) Time and method of making election. (1) An election under 
section 754 and this section to adjust the basis of partnership property 
under sections 734(b) and 743(b), with respect to a distribution of 
property to a partner or a transfer of an interest in a partnership, 
shall be made in a written statement filed with the partnership return 
for the taxable year during which the distribution or transfer occurs. 
For the election to be valid, the return must be filed not later than 
the time prescribed by paragraph (e) of Sec. 1.6031-1 (including 
extensions thereof) for filing the return for such taxable year (or 
before August 23, 1956, whichever is later). Notwithstanding the 
preceding two sentences, if a valid election has been made under section 
754 and this section for a preceding taxable year and not revoked 
pursuant to paragraph (c) of this section, a new election is not 
required to be made. The statement required by this subparagraph shall 
(i) set forth the name and address of the partnership making the 
election, (ii) be signed by any one of the partners, and (iii) contain a 
declaration that the partnership elects under section 754 to apply the 
provisions of section 734(b) and section 743(b). For rules regarding 
extensions of time for filing elections, see Sec. 1.9100-1.
    (2) The principles of this paragraph may be illustrated by the 
following example:


[[Page 484]]


    Example. A, a U.S. citizen, is a member of partnership ABC, which 
has not previously made an election under section 754 to adjust the 
basis of partnership property. The partnership and the partners use the 
calendar year as the taxable year. A sells his interest in the 
partnership to D on January 1, 1971. The partnership may elect under 
section 754 and this section to adjust the basis of partnership property 
under sections 734(b) and 743(b). Unless an extension of time to make 
the election is obtained under the provisions of Sec. 1.9100-1, the 
election must be made in a written statement filed with the partnership 
return for 1971 and must contain the information specified in 
subparagraph (1) of this paragraph. Such return must be filed by April 
17, 1972 (unless an extension of time for filing the return is 
obtained). The election will apply to all distributions of property to a 
partner and transfers of an interest in the partnership occurring in 
1971 and subsequent years, unless revoked pursuant to paragraph (c) of 
this section.

    (c) Revocation of election. A partnership having an election in 
effect under this section may revoke such election with the approval of 
the district director for the internal revenue district in which the 
partnership return is required to be filed. A partnership which wishes 
to revoke such an election shall file with the district director for the 
internal revenue district in which the partnership return is required to 
be filed an application setting forth the grounds on which the 
revocation is desired. The application shall be filed not later than 30 
days after the close of the partnership taxable year with respect to 
which revocation is intended to take effect and shall be signed by any 
one of the partners. Examples of situations which may be considered 
sufficient reason for approving an application for revocation include a 
change in the nature of the partnership business, a substantial increase 
in the assets of the partnership, a change in the character of 
partnership assets, or an increased frequency of retirements or shifts 
of partnership interests, so that an increased administrative burden 
would result to the partnership from the election. However, no 
application for revocation of an election shall be approved when the 
purpose of the revocation is primarily to avoid stepping down the basis 
of partnership assets upon a transfer or distribution.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7208, 37 FR 
20686, Oct. 3, 1972]



Sec. 1.755-1   Rules for allocation of basis.

    (a) General rule. (1)(i) A partnership which has elected under 
section 754 must adjust the basis of partnership property under the 
provisions of section 734(b) (relating to the optional adjustment to the 
basis of undistributed partnership property) and section 743(b) 
(relating to the optional adjustment to the basis of partnership 
property where a partnership interest is transferred). The amount of the 
increase or decrease (as determined in those sections) in the adjusted 
basis of the partnership property shall first be divided, under 
paragraph (b) of this section, between the two classes of property 
described in section 755(b). Then, the portion of the increase or 
decrease allocated to each class shall be further allocated to the bases 
of the properties within the class in a manner which will reduce the 
difference between the fair market value and the adjusted basis of 
partnership properties. In the alternative, any increase or decrease may 
be allocated in any other manner approved by the district director under 
subparagraph (2) of this paragraph.
    (ii) If there is an increase in basis to be allocated to partnership 
assets, such increase must be allocated only to assets whose values 
exceed their bases and in proportion to the difference between the value 
and basis of each. No increase shall be made to the basis of any asset 
the adjusted basis of which equals or exceeds its fair market value.
    (iii) If there is a decrease in basis to be allocated to partnership 
assets, such decrease must be allocated to assets whose bases exceed 
their value and in proportion to the difference between the basis and 
value of each. No decrease shall be made to the basis of any asset, the 
fair market value of which equals or exceeds its adjusted basis.
    (iv) The application of the rules with respect to the allocation of 
an adjustment in basis under subdivisions (ii) and (iii) of this 
subparagraph requires that a portion of such adjustment be allocated to 
partnership good will, to

[[Page 485]]

the extent that good will exists and is reflected in the value of the 
property distributed, the price at which the partnership interest is 
sold, or the basis of the partnership interest determined under section 
1014, in accordance with the difference between such value of the good 
will and its adjusted basis at the time of the transaction.
    (2) If a partnership (or a partner electing under section 732(d)) 
desires to adjust the basis of assets under section 734(b) or 743(b) in 
a manner other than that prescribed in subparagraph (1) of this 
paragraph, it must file an application for permission to use such method 
with the district director no later than 30 days after the close of the 
partnership taxable year in which the proposed adjustment is to be made. 
The application must describe the proposed adjustments in detail and set 
forth the reasons for the desired use of the other method. Under section 
755(a)(2), the district director may permit the partnership to increase 
the bases of some partnership properties and decrease the bases of other 
partnership properties under section 734(b) or 743(b). Each increase or 
decrease to the basis of an asset must reduce or eliminate the 
difference between such basis and the value of the asset. The net amount 
of all such adjustments must equal the amount of the adjustment under 
section 734(b) or 743(b). Adjustments that both increase and decrease 
the basis of partnership assets will be permitted by the district 
director only upon a satisfactory showing of the values for partnership 
assets used by the parties to determine the price at which a partnership 
interest was sold, the value of the decedent's partnership interest at 
date of death (or at the alternate valuation date, if used), or the 
amount of a distribution.
    (b) Special rules. For the purposes of applying section 755, all 
partnership property shall be classified into two categories: Capital 
assets and property described in section 1231(b) (certain property used 
in the trade or business), or any other property of the partnership.
    (1) Distributions. (i) Where there is a distribution of partnership 
property resulting in an adjustment to the basis of undistributed 
partnership property under section 734(b)(1)(B) or (b)(2)(B), such 
adjustment must be allocated to remaining partnership property of a 
character similar to that of the distributed property with respect to 
which the adjustment arose. Thus, when the partnership adjusted basis of 
distributed capital assets and section 1231(b) property immediately 
prior to distribution exceeds the basis of such property to the 
distributee partner (as determined under section 732), the basis of the 
undistributed capital assets and section 1231(b) property remaining in 
the partnership shall be increased by an amount equal to such excess. 
Conversely, when the basis to the distributee partner (as determined 
under section 732) of distributed capital assets and section 1231(b) 
property exceeds the partnership adjusted basis of such property 
immediately prior to the distribution, the basis of the undistributed 
capital assets and section 1231(b) property remaining in the partnership 
shall be decreased by an amount equal to such excess. Similarly, where 
there is a distribution of partnership property other than capital 
assets and section 1231(b) property, and the basis of such other 
property to the distributee partner (as determined under section 732) is 
not the same as the partnership adjusted basis of such property 
immediately prior to distribution, the adjustment shall be made only to 
undistributed property of the same category remaining in the 
partnership.
    (ii) Where there is a distribution resulting in an adjustment under 
section 734(b)(1)(A) or (b)(2)(A) to the basis of undistributed 
partnership property, such adjustment must be allocated only to capital 
assets or section 1231(b) property.
    (2) Transfers. Where there is a basis adjustment under section 
743(b) arising from a transfer of an interest in a partnership by sale 
or exchange or upon the death of a partner, the amount of the adjustment 
shall be allocated between the two classes of property described in 
section 755(b) and then the amount allocated to each class shall be 
further allocated under the rules of paragraph (a)(1) of this section. 
Thus, to the extent that an amount paid by a purchaser of a partnership 
interest (or the basis of the partnership interest to the

[[Page 486]]

estate or other successor in interest of a deceased partner) is 
attributable to the value of capital assets and section 1231(b) 
property, any difference between the amount so attributable and the 
transferee partner's share of the partnership basis of such property 
shall constitute a special basis adjustment with respect to partnership 
capital assets and section 1231 (b) property. Similarly, any such 
difference attributable to any other property of the partnership shall 
constitute a special basis adjustment with respect to such property.
    (3) Limitation on decrease of basis. Where a decrease in the basis 
of partnership assets is required under section 734(b)(2) and the amount 
of the decrease exceeds the adjusted basis to the partnership of 
property of the required character, the basis of such property shall be 
reduced to zero (but not below zero), and the balance of the decrease in 
basis shall be made when the partnership subsequently acquires property 
of a like character to which an adjustment can be made.
    (4) Carryover of adjustment. Where, in the case of a distribution, 
an increase or decrease required under paragraph (a) of this section in 
the basis of undistributed partnership property cannot be made because 
the partnership owns no property of the character required to be 
adjusted, or because the adjustment has been limited under subparagraph 
(3) of this paragraph, the adjustment shall be made when the partnership 
subsequently acquires property of a like character to which an 
adjustment can be made.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example (1). Assume that partnership ABC has three assets: X, a 
capital asset with an adjusted basis of $1,000 and a value of $1,500; Y, 
a depreciable asset with an adjusted basis of $1,000 and a value of 
$900; and Z, inventory items with an adjusted basis of $700 and a value 
of $600. A sells his interest to D (when an election under 754 is in 
effect) for $1,000 ( 1/3 of $3,000, the total value of partnership 
assets). D's share of the adjusted basis of partnership property is $900 
( 1/3 of $2,700). Therefore, under section 743(b), D has a special basis 
adjustment of $100 ($1,000 minus $900). This adjustment must be 
allocated entirely to property X, since such allocation will have the 
effect of reducing the difference between the value and basis of such 
asset. Therefore, D has a special basis adjustment of $100 with respect 
to property X, which now has a special basis to him of $1,100. No part 
of the adjustment is made to depreciable property Y or inventory items 
Z, since any such adjustment would increase the difference between the 
basis and value of each such asset.
    Example (2). Assume the same facts as in example 1 of this 
paragraph, except that capital asset X has a value of $1,500, 
depreciable property Y has a value of $1,100, and inventory items Z have 
a value of only $400. Therefore, under section 743(b), D has a special 
basis adjustment of $100, the excess of D's basis for his interest in 
the partnership ($1,000) over his share of the adjusted basis of 
partnership property ($900). This $100 adjustment must be allocated 
entirely to capital asset X and depreciable property Y in proportion to 
the difference between the value and basis of each since such allocation 
has the effect of reducing the difference between the value and basis of 
each such asset. Therefore, D has a special basis adjustment of $83 
($500/$600 of $100) with respect to capital asset X, which now has a 
special basis to him of $1,083, and of $17 ($100/$600 of $100) with 
respect to depreciable property Y, which now has a special basis to him 
of $1,017. No part of the adjustment is made to inventory items Z, since 
any such adjustment would increase the difference between the basis of 
such asset and its value.
    Example (3). Assume that partnership EFG has three assets: X, a 
capital asset with an adjusted basis of $1,000 and a value of $1,500; Y, 
a depreciable asset with an adjusted basis of $1,000 and a value of 
$700; and Z, inventory items with an adjusted basis of $700 and a value 
of $800. E sells his interest to H (when an election under section 754 
is in effect) for $1,000 (1/3 of $3,000, the total value of the 
partnership assets). H's share of the adjusted basis of partnership is 
$900 (1/3 of $2,700). Therefore, H has a special basis adjustment of 
$100 ($1,000 minus $900) under section 743(b). Since, of the total $300 
difference between the value and the adjusted basis of all partnership 
property, $200 ($500, appreciation in value of X, minus $300, 
depreciation in value of Y) is attributable to the class of capital 
assets and depreciable property, and $100 (appreciation in value of 
inventory items Z) to the class of other property, H's special basis 
adjustment of $100 must be allocated 2/3 to capital assets and 
depreciable property and 1/3 to other property (inventory). The $67 
increase (2/3 of $100) to be allocated to capital assets and depreciable 
property must further be allocated so as to reduce the difference 
between the value and basis of such assets. This can be done only by 
allocating the entire $67 increase to capital asset X (the basis of 
which is less than its

[[Page 487]]

value), and no part of the increase to depreciable property Y (the basis 
of which exceeds its value). Therefore, H has a special basis adjustment 
of $67 for capital asset X, which now has a special basis to him of 
$1,067; he has no special basis adjustment for depreciable property Y. H 
also has a special basis adjustment of $33 (1/3 of $100) for inventory 
items Z, the special basis of which is now $733.



Sec. 1.755-2T  Coordination of sections 755 and 1060 (temporary).

    (a) Coordination with section 1060--(1) In general. If there is a 
basis adjustment to which this section applies--
    (i) The fair market value of each item of partnership property must 
be determined under this section; and
    (ii) The rules of Sec. 1.755-1 must be applied using the values so 
determined.
    (2) Application of this section. This section applies to any basis 
adjustment made under section 743(b) (relating to certain transfers of 
interests in a partnership) or section 732(d) (relating to certain 
partnership distributions), if assets of the partnership constitute a 
trade or business for purposes of section 1060(c).
    (b) Determining the fair market value of partnership property--(1) 
Property other than that in the nature of goodwill or going concern 
value. For purposes of this section, the fair market value of each item 
of partnership property (other than property in the nature of goodwill 
or going concern value) shall be determined on the basis of all the 
facts and circumstances.
    (2) Property in the nature of goodwill or going concern value. For 
purposes of paragraph (a) of this section, the fair market value of 
partnership property in the nature of goodwill or going concern value 
(referred to hereinafter in this section as goodwill) shall be deemed to 
equal the amount (not below zero) which if assigned to such property 
would result in a liquidating distribution to the transferee partner 
equal to such partner's basis for the transferred partnership interest 
immediately after the transfer (reduced by the amount, if any, of such 
basis that is attributable to partnership liabilities) if--
    (i) All partnership property were sold immediately after such 
transfer for an amount equal to the fair market value of such property 
(as determined under this section), and
    (ii) The proceeds of that sale were, after the payment of all 
partnership liabilities (within the meaning of section 752 and the 
regulations thereunder), distributed to the partners.
    (c) Cross-reference. See Secs. 1.732-1(d)(3) and 1.743-1(b)(3) for 
rules requiring a transferee partner to attach a statement to such 
partner's return showing the computation of the special basis adjustment 
and the partnership properties to which the adjustment is allocated 
under section 755.
    (d) Effective date. This section applies to any basis adjustment 
under section 743(b) made as a result of any transfer of a partnership 
interest made after May 6, 1986, unless such transfer is made pursuant 
to a binding contract that was in effect on May 6, 1986, and at all 
times thereafter prior to such transfer. However, the requirements of 
this section shall be deemed to be satisfied with respect to any 
transfer made on or before July 15, 1988, if the amount of any basis 
adjustment under section 743(b) or section 732(d) made as a result of 
such transfer that is allocated to each item of partnership property 
(other than goodwill) does not exceed the amount equal to the difference 
between the transferee partner's share of the partnership basis of such 
property and such partner's share of the fair market value of such 
property.
    (e) Example. The provisions of this section may be illustrated by 
the following example which assumes that the assets of the partnership 
constitute a trade or business under section 1060 and that the 
partnership has an election in effect under section 754 at the time of 
the sale of the partnership interest.

    Example (1). A is a member of partnership ABC. ABC has three assets: 
a building with a fair market value of $2,000,000, equipment with a fair 
market value of $800,000 and goodwill. ABC has no liabilities. A has a 
one-third interest in partnership capital and profits. A sells his 
partnership interest to D for $1,000,000. Under paragraph (b)(2) of this 
section, the fair market value of goodwill is deemed to equal the value 
that must be assigned to goodwill in order for the partnership to 
distribute $1,000,000 to D if it were to sell all of its property at 
fair market value

[[Page 488]]

(in the case of goodwill, its assigned value) and completely liquidate 
after D's purchase of A's partnership interest. In order for D, a one-
third partner, to receive a liquidation distribution of $1,000,000, the 
partnership would have to sell all partnership property for a total of 
$3,000,000. The fair market value of partnership property other than 
goodwill is $2,800,000. Therefore, goodwill must be assigned a value of 
$200,000 ($3,000,000 - $2,800,000) in order for D to receive a 
liquidating distribution of $1,000,000. Accordingly, D's section 743(b) 
basis adjustment must be allocated under Sec. 1.755-1 using a fair 
market value of $200,000 for goodwill.


[T.D. 8215, 53 FR 27044, July 18, 1988]

                               Definitions



Sec. 1.761-1   Terms defined.

    (a) Partnership. The term partnership means a partnership as 
determined under Secs. 301.7701-1, 301.7701-2, and 301.7701-3 of this 
chapter.
    (b) Partner. The term partner means a member of a partnership.
    (c) Partnership agreement. For the purposes of subchapter K, a 
partnership agreement includes the original agreement and any 
modifications thereof agreed to by all the partners or adopted in any 
other manner provided by the partnership agreement. Such agreement or 
modifications can be oral or written. A partnership agreement may be 
modified with respect to a particular taxable year subsequent to the 
close of such taxable year, but not later than the date (not including 
any extension of time) prescribed by law for the filing of the 
partnership return. As to any matter on which the partnership agreement, 
or any modification thereof, is silent, the provisions of local law 
shall be considered to constitute a part of the agreement.
    (d) Liquidation of partner's interest. The term liquidation of a 
partner's interest means the termination of a partner's entire interest 
in a partnership by means of a distribution, or a series of 
distributions, to the partner by the partnership. A series of 
distributions will come within the meaning of this term whether they are 
made in one year or in more than one year. Where a partner's interest is 
to be liquidated by a series of distributions, the interest will not be 
considered as liquidated until the final distribution has been made. For 
the basis of property distributed in one liquidating distribution, or in 
a series of distributions in liquidation, see section 732(b). A 
distribution which is not in liquidation of a partner's entire interest, 
as defined in this paragraph, is a current distribution. Current 
distributions, therefore, include distributions in partial liquidation 
of a partner's interest, and distributions of the partner's distributive 
share. See paragraph (a)(1)(ii) of Sec. 1.731-1.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 7208, 37 FR 
20686, Oct. 3, 1972; T.D. 8697, 61 FR 66588, Dec. 18, 1996]



Sec. 1.761-2   Exclusion of certain unincorporated organizations from the application of all or part of subchapter K of chapter 1 of the Internal Revenue Code.

    (a) Exclusion of eligible unincorporated organizations--(1) In 
general. Under conditions set forth in this section, an unincorporated 
organization described in subparagraph (2) or (3) of this paragraph may 
be excluded from the application of all or a part of the provisions of 
subchapter K of chapter 1 of the Code. Such organization must be availed 
of (i) for investment purposes only and not for the active conduct of a 
business, or (ii) for the joint production, extraction, or use of 
property, but not for the purpose of selling services or property 
produced or extracted. The members of such organization must be able to 
compute their income without the necessity of computing partnership 
taxable income. Any syndicate, group, pool, or joint venture which is 
classifiable as an association, or any group operating under an 
agreement which creates an organization classifiable as an association, 
does not fall within these provisions.
    (2) Investing partnership. Where the participants in the joint 
purchase, retention, sale, or exchange of investment property:
    (i) Own the property as coowners,
    (ii) Reserve the right separately to take or dispose of their shares 
of any property acquired or retained, and
    (iii) Do not actively conduct business or irrevocably authorize some 
person or persons acting in a representative capacity to purchase, sell, 
or exchange

[[Page 489]]

such investment property, although each separate participant may 
delegate authority to purchase, sell, or exchange his share of any such 
investment property for the time being for his account, but not for a 
period of more than a year, then

such group may be excluded from the application of the provisions of 
subchapter K under the rules set forth in paragraph (b) of this section.
    (3) Operating agreements. Where the participants in the joint 
production, extraction, or use of property:
    (i) Own the property as coowners, either in fee or under lease or 
other form of contract granting exclusive operating rights, and
    (ii) Reserve the right separately to take in kind or dispose of 
their shares of any property produced, extracted, or used, and
    (iii) Do not jointly sell services or the property produced or 
extracted, although each separate participant may delegate authority to 
sell his share of the property produced or extracted for the time being 
for his account, but not for a period of time in excess of the minimum 
needs of the industry, and in no event for more than 1 year, then

such group may be excluded from the application of the provisions of 
subchapter K under the rules set forth in paragraph (b) of this section. 
However, the preceding sentence does not apply to any unincorporated 
organization one of whose principal purposes is cycling, manufacturing, 
or processing for persons who are not members of the organization. In 
addition, except as provided in paragraph (d)(2)(i) of this section, 
this paragraph (a)(3) does not apply to any unincorporated organization 
that produces natural gas under a joint operating agreement, unless all 
members of the unincorporated organization comply with paragraph (d) of 
this section.
    (b) Complete exclusion from subchapter K--(1) Time for making 
election for exclusion. Any unincorporated organization described in 
subparagraph (1) and either (2) or (3) of paragraph (a) of this section 
which wishes to be excluded from all of subchapter K must make the 
election provided in section 761(a) not later than the time prescribed 
by paragraph (e) of Sec. 1.6031-1 (including extensions thereof) for 
filing the partnership return for the first taxable year for which 
exclusion from subchapter K is desired. Notwithstanding the prior 
sentence such organization may be deemed to have made the election in 
the manner prescribed in subparagraph (2)(ii) of this paragraph.
    (2) Method of making election. (i) Except as provided in subdivision 
(ii) of this subparagraph, any unincorporated organization described in 
subparagraphs (1) and either (2) or (3) of paragraph (a) of this section 
which wishes to be excluded from all of subchapter K must make the 
election provided in section 761(a) in a statement attached to, or 
incorporated in, a properly executed partnership return, Form 1065, 
which shall contain the information required in this subdivision. Such 
return shall be filed with the internal revenue officer with whom a 
partnership return, Form 1065, would be required to be filed if no 
election were made. Where, for the purpose of determining such officer, 
it is necessary to determine the internal revenue district (or service 
center serving such district) in which the electing organization has its 
principal office or place of business, the principal office or place of 
business of the person filing the return shall be considered the 
principal office or place of business of the organization. The 
partnership return must be filed not later than the time prescribed by 
paragraph (e) of Sec. 1.6031-1 (including extensions thereof) for filing 
the partnership return with respect to the first taxable year for which 
exclusion from subchapter K is desired. Such partnership return shall 
contain, in lieu of the information required by Form 1065 and by the 
instructions relating thereto, only the name or other identification and 
the address of the organization together with information on the return, 
or in the statement attached to the return, showing the names, 
addresses, and identification numbers of all the members of the 
organization; a statement that the organization qualifies under 
subparagraphs (1) and either (2) or (3) of paragraph (a) of this 
section; a statement that all of the members of the organization elect 
that it be excluded from all of subchapter K; and a

[[Page 490]]

statement indicating where a copy of the agreement under which the 
organization operates is available (or if the agreement is oral, from 
whom the provisions of the agreement may be obtained).
    (ii) If an unincorporated organization described in subparagraphs 
(1) and either (2) or (3) of paragraph (a) of this section does not make 
the election provided in section 761(a) in the manner prescribed by 
subdivision (i) of this subparagraph, it shall nevertheless be deemed to 
have made the election if it can be shown from all the surrounding facts 
and circumstances that it was the intention of the members of such 
organization at the time of its formation to secure exclusion from all 
of subchapter K beginning with the first taxable year of the 
organization. Although the following facts are not exclusive, either one 
of such facts may indicate the requisite intent:
    (a) At the time of the formation of the organization there is an 
agreement among the members that the organization be excluded from 
subchapter K beginning with the first taxable year of the organization, 
or
    (b) The members of the organization owning substantially all of the 
capital interests report their respective shares of the items of income, 
deductions, and credits of the organization on their respective returns 
(making such elections as to individual items as may be appropriate) in 
a manner consistent with the exclusion of the organization from 
subchapter K beginning with the first taxable year of the organization.
    (3) Effect of election--(i) In general. An election under this 
section to be excluded will be effective unless within 90 days after the 
formation of the organization (or by October 15, 1956, whichever is 
later) any member of the organization notifies the Commissioner that the 
member desires subchapter K to apply to such organization, and also 
advises the Commissioner that he has so notified all other members of 
the organization by registered or certified mail. Such election is 
irrevocable as long as the organization remains qualified under 
subparagraphs (1) and either (2) or (3) of paragraph (a) of this 
section, or unless approval of revocation of the election is secured 
from the Commissioner. Application for permission to revoke the election 
must be submitted to the Commissioner of Internal Revenue, Attention: 
T:I, Washington, DC 20224, no later than 30 days after the beginning of 
the first taxable year to which the revocation is to apply.
    (ii) Special rule. Notwithstanding subdivision (i) of this 
subparagraph, an election deemed made pursuant to subparagraph (2)(ii) 
of this paragraph will not be effective in the case of an organization 
which had a taxable year ending on or before November 30, 1972, if any 
member of the organization notifies the Commissioner that the member 
desires subchapter K to apply to such organization, and also advises the 
Commissioner that he has so notified all other members of the 
organization by registered or certified mail. Such notification to the 
Commissioner must be made on or before January 2, 1973 and must include 
the names and addresses of all of the members of the organization.
    (c) Partial exclusion from subchapter K. An unincorporated 
organization which wishes to be excluded from only certain sections of 
subchapter K must submit to the Commissioner, no later than 90 days 
after the beginning of the first taxable year for which partial 
exclusion is desired, a request for permission to be excluded from 
certain provisions of subchapter K. The request shall set forth the 
sections of subchapter K from which exclusion is sought and shall state 
that such organization qualifies under subparagraphs (1) and either (2) 
or (3) of paragraph (a) of this section, and that the members of the 
organization elect to be excluded to the extent indicated. Such 
exclusion shall be effective only upon approval of the election by the 
Commissioner and subject to the conditions he may impose.
    (d) Rules for gas producers that produce natural gas under joint 
operating agreements--(1) Joint operating agreements and gas balancing. 
Co-owners of a property producing natural gas enter into a joint 
operating agreement (JOA) to define the rights and obligations of each 
co- producer of the gas in place. The JOA determines, among other 
things, each co-producer's proportionate share of the natural gas as it 
is produced

[[Page 491]]

from the reservoir, together with the associated production expenses. A 
gas imbalance arises when a co-producer does not take its proportionate 
share of current gas production under the JOA (underproducer) and 
another co-producer takes more than its proportionate share of current 
production (overproducer). The co-producers often enter into a gas 
balancing agreement (GBA) as an addendum to their JOA to establish their 
rights and obligations when a gas imbalance arises. A GBA typically 
allows the overproducer to take the amount of the gas imbalance 
(overproduced gas) and entitles the underproducer to recoup the 
overproduced gas either from the volume of the gas remaining in the 
reservoir or by a cash balancing payment.
    (2) Permissible gas balancing methods--(i) General requirement. All 
co-producers of natural gas operating under the same JOA must use the 
cumulative gas balancing method, as described in paragraph (d)(3) of 
this section, unless they use the annual gas balancing method described 
in paragraph (d)(4) of this section. A co-producer's failure to comply 
with the provisions of this paragraph (d)(2)(i) generally constitutes 
the use of an impermissible method of accounting, requiring a change to 
a permissible method under Sec. 1.446-1(e)(3) with any terms and 
conditions as may be imposed by the Commissioner. The co-producers' 
election to be excluded from all or part of subchapter K will not be 
revoked, unless the Commissioner determines that there was willful 
failure to comply with the requirements of this paragraph (d)(2)(i).
    (ii) Change in method of accounting; adoption of method of 
accounting--(A) In general. The annual gas balancing method and the 
cumulative gas balancing method are methods of accounting. Accordingly, 
a change to or from either of these methods is a change in method of 
accounting that requires the consent of the Commissioner. See section 
446(e) and Sec. 1.446-1(e). For purposes of this section, each JOA is 
treated as a separate trade or business. Paragraph (d)(2)(ii)(B) of this 
section provides rules for adopting either permissible method of 
accounting. Paragraph (d)(2)(ii)(C) of this section provides rules on 
the timing of required changes to either permissible method during the 
transitional period, and paragraph (d)(5) of this section contains the 
procedural provisions for making a change in method of accounting 
required in paragraph (d)(2)(ii)(C) of this section.
    (B) Adoption of method of accounting. A co-producer must adopt a 
permissible method for each JOA entered into on or after the start of 
the co-producer's first taxable year beginning after December 31, 1994 
(or, in the case of the use of the annual gas balancing method by co-
producers not having the same taxable year, the start of the first 
taxable year beginning after December 31, 1994, of the co-producer whose 
taxable year begins latest in the calendar year). If a co-producer is 
adopting the cumulative method, the co-producer may adopt the method by 
using the method on its timely filed return for the taxable year of 
adoption. A co-producer may adopt the annual gas balancing method with 
the permission of the Commissioner under guidelines set forth in 
paragraph (d)(4)(ii) of this section.
    (C) Required change in method of accounting for certain joint 
operating agreements. This paragraph (d)(2)(ii)(C) applies to certain 
JOAs entered into prior to 1996. Except in the case of a part-year 
change in method of accounting or in the case of the cessation of a JOA 
(both of which are described in this paragraph (d)(2)(ii)(C)), for each 
JOA entered into prior to a co-producer's first taxable year beginning 
after December 31, 1994, and in effect as of the beginning of that year, 
the co-producer must change its method of accounting for sales of gas 
and its treatment of certain related deductions and credits to a 
permissible method as of the start of its first taxable year beginning 
after December 31, 1994. In the case of a JOA of co-producers that do 
not all have the same taxable year and that choose the annual gas 
balancing method, if the JOA is entered into prior to the first taxable 
year beginning after December 31, 1994 of the co-producer whose taxable 
year begins latest in the calendar year and the JOA is in effect as of 
January 1, 1996, a change to the annual gas balancing method by each co-
producer under that JOA is made as of January 1, 1996 (part-year change 
in method of

[[Page 492]]

accounting). If the co-producers would have made a part-year change to 
the annual gas balancing method but for the fact that their JOA ceased 
to be in effect before January 1, 1996 (cessation of a JOA), the co-
producers do not change their method of accounting with respect to the 
JOA. Rather, for their taxable years in which the JOA ceases to be in 
effect, the co-producers use their current method of accounting with 
respect to that JOA.
    (3) Cumulative gas balancing method--(i) In general. The cumulative 
gas balancing method (cumulative method), solely for purposes of 
reporting income from gas sales and certain related deductions and 
credits, treats each co-producer under the same JOA as the sole owner of 
its percentage share of the total gas in the reservoir and disregards 
the ownership arrangement described in the JOA for gas as it is produced 
from the reservoir. Each co-producer is considered to be taking only its 
share of the total gas in the reservoir as long as the gas remaining in 
the reservoir is sufficient to satisfy the ownership rights of the co-
producers in their percentage shares of the total gas in the reservoir. 
After a co-producer has taken its entire share of the total gas in the 
reservoir, any additional gas taken by that co-producer (taking co-
producer) is treated as having been taken from its other co-producers' 
shares of the total gas in the reservoir. The effect of being treated as 
a taking co-producer under the cumulative method is that the taking co-
producer generally may not claim an allowance for depletion and a 
production credit on its sales of its other co-producers' percentage 
shares of the total gas in the reservoir.
    (ii) Requirements--(A) Reporting of income from sales of gas. Under 
the cumulative method, each co-producer must include in gross income 
under its overall method of accounting the amount of its sales from all 
gas produced from the reservoir, including sales of gas taken from 
another co-producer's share of the gas in the reservoir.
    (B) Reporting of deduction of taking co-producer. A taking co-
producer deducts the amount of a payment (in cash or property, other 
than gas produced under the JOA) made to another co-producer for sales 
of that co-producer's gas, but only for the taxable year in which the 
payment is made. Thus, an accrual method taking co-producer is not 
permitted a deduction for any obligation it has to pay another co-
producer for sales of that co-producer's gas until a payment is made. 
See paragraph (d)(3)(iii)(B) of this section for a rule requiring a 
reduction of the amount of the deduction described in this paragraph 
(d)(3)(ii)(B) if the taking co-producer had mistakenly claimed a 
depletion deduction relating to those sales.
    (C) Reporting of income by other co-producers. Any co-producer that 
is entitled to receive a payment from a taking co-producer must include 
the amount of the payment in gross income as proceeds from the sale of 
its gas only for the taxable year that the payment is actually received, 
regardless of its overall method of accounting.
    (D) Reporting of production expenses. Each co-producer deducts its 
proportionate share of production expenses, as provided in the JOA, 
under its regular method of accounting for the expenses.
    (iii) Special rules for production credits and depletion deductions 
under the cumulative method--(A) In general. Under the cumulative 
method, a co-producer's depletion allowance and production credit for a 
taxable year are based on its income from gas sales and production of 
gas from its percentage share of the total gas in the reservoir, and are 
not based on its current proportionate share of income and production as 
determined under the JOA. Thus, in general, a taking co-producer is not 
allowed a production credit or an allowance for depletion on its sales 
of gas in excess of its percentage share of the total gas in the 
reservoir. However, the Service will not disallow depletion deductions 
or production credits claimed by a taking co-producer on the gas of 
other co-producers if the taking co-producer had a reasonable but 
mistaken belief that the deductions or credits were claimed with respect 
to the taking co-producer's percentage share of total gas in the 
reservoir and the taking co-producer makes the appropriate reductions 
and additions to tax required in paragraphs (d)(3)(iii)(B) and

[[Page 493]]

(d)(3)(iii)(C) of this section. The reasonableness of the mistaken 
belief is determined at the time of filing the return claiming the 
deductions or credits. A co-producer receiving a payment for sales of 
its gas from a taking co-producer claims a production credit and an 
allowance for depletion relating to those sales only for the taxable 
year in which the amount of the payment is included in its gross income.
    (B) Reduction of taking co-producer's payment deduction for 
depletion claimed on another co-producer's gas. If a taking co-producer 
claims an allowance for depletion on another co-producer's gas, the 
taking co-producer must reduce its deduction claimed in a later year for 
making a payment to the other co-producer for sales of that co-
producer's gas by the amount of any percentage depletion deduction 
allowed on the gas sales to which the payment relates. If the percentage 
limitation of section 613A(d)(1) applied to disallow a depletion 
deduction for a previous year, the taking co-producer must reduce the 
amount of any carried over depletion deduction allowable in the year of 
the payment or in a future year by the portion of the carried over 
depletion deduction, if any, that relates to another co-producer's gas.
    (C) Addition to tax of taking co-producer for production credit 
claimed on another co-producer's gas. If a taking co-producer claims a 
production credit on another co-producer's gas, the taking co-producer 
must add to its tax for the taxable year that it makes a payment to the 
other co-producer for sales of that co-producer's gas any production 
credit allowed in an earlier taxable year on the gas sales to which the 
payment relates, but only to the extent the credit allowed actually 
reduced the taking co- producer's tax in any earlier year. The taking 
co-producer also must reduce the amount of its minimum tax credit 
allowable by reason of section 53(d)(1)(B)(iii) in the year of the 
payment or in a future year by the portion of the credit, if any, that 
relates to another co-producer's gas.
    (iv) Anti-abuse rule. If the Commissioner determines that co-
producers using the cumulative method have arranged or altered their 
taking of production for a taxable year with a principal purpose of 
shifting the income, deductions, or credits relating to that production 
to avoid tax, the co- producers' election to be excluded from all or 
part of subchapter K will be revoked for that year and for subsequent 
years. In determining that a principal purpose was to avoid tax, the 
Commissioner will examine all the facts and circumstances surrounding 
the use of the cumulative method by the co-producers. See Examples 3 and 
4 of paragraph (d)(6) of this section.
    (4) Annual gas balancing method--(i) In general. The annual gas 
balancing method (annual method) takes into account each co-producer's 
ownership rights and obligations, as described in the JOA, with respect 
to the co-producer's current proportionate share of gas as it is 
produced from the reservoir. Under the annual method, gas imbalances 
relating to a JOA must be eliminated annually through a balancing 
payment, which may be in the form of cash, gas produced under the same 
JOA, or other property. If all the co-producers under a JOA have the 
same taxable year, any gas imbalance remaining at the end of a taxable 
year must be eliminated by a balancing payment from the overproducer to 
the underproducer by the due date of the overproducer's tax return for 
that taxable year (including extensions). If all the co-producers under 
a JOA do not have the same taxable year, any gas imbalance remaining at 
the end of a calendar year must be eliminated by a balancing payment 
from the overproducer to the underproducer by September 15 of the 
following calendar year. The annual method may be used only if the 
Commissioner's permission is obtained. Paragraph (d)(4)(ii) of this 
section provides guidelines for applying for this permission. The annual 
method is not available for a JOA with respect to which any co-producer 
made an election under paragraph (d)(5)(i)(B)(3) of this section (to 
take an aggregate section 481(a) adjustment for all JOAs of a co-
producer into account in the year of change).
    (ii) Obtaining the Commissioner's permission to use the annual 
method. A request for the Commissioner's permission to adopt the annual 
method for a new JOA must be in writing and must

[[Page 494]]

set forth the names of all the co-producers under the JOA and the 
respective taxable year of adoption. See paragraphs (d)(2)(ii) and 
(d)(5)(ii) of this section for the rules for a change in method of 
accounting to the annual method. In addition, the request must contain 
an explanation of how the co-producers will report income from gas 
sales, the making or receiving of a balancing payment, production 
expenses, depletion deductions, and production credits. Permission will 
be granted under appropriate conditions, including, but not limited to, 
an agreement in writing by all co-producers to use the annual method and 
to eliminate any gas imbalances annually in accordance with paragraph 
(d)(4)(i) of this section.
    (5) Transitional rules for making a change in method of accounting 
required in paragraph (d)(2)(ii)(C) of this section--(i) Change in 
method of accounting to the cumulative method--(A) Automatic consent to 
change in method of accounting to the cumulative method. A co-producer 
changing to the cumulative method for any JOA entered into prior to its 
first taxable year beginning after December 31, 1994, and in effect as 
of the beginning of that year is granted the consent of the Commissioner 
to change its method of accounting with respect to each JOA to the 
cumulative method, provided the co-producer--
    (1) Makes the change on its timely filed return for its first 
taxable year beginning after December 31, 1994;
    (2) Attaches a completed and signed Form 3115 to the co-producer's 
tax return for the year of change, stating that, pursuant to Sec. 1.761-
2(d)(2)(ii) of the regulations, the co-producer is changing its method 
of accounting for sales of gas and its treatment of certain related 
deductions and credits under each JOA to the cumulative method;
    (3) In the case of a co-producer making an election under paragraph 
(d)(5)(i)(B)(3) of this section to take the aggregate section 481(a) 
adjustment into account in the year of change, attaches the statement 
described in paragraph (d)(5)(i)(B)(3)(ii) of this section; and
    (4) In the case of a co-producer not making an election under 
paragraph (d)(5)(i)(B)(3) of this section, attaches a list of each JOA 
with respect to which there is a section 481(a) adjustment computed in 
accordance with paragraph (d)(5)(i)(B)(2)(i) of this section.
    (B) Section 481(a) adjustment--(1) Application of section 481(a). A 
change in method of accounting to the cumulative method under the 
automatic consent procedure in paragraph (d)(5)(i)(A) of this section is 
a change in method of accounting to which the provisions of section 
481(a) apply. Thus, a section 481(a) adjustment must be taken into 
account in the manner provided by this paragraph (d)(5)(i)(B) to prevent 
the omission or duplication of income. Paragraph (d)(5)(i)(B)(2) of this 
section provides the general rules for computing the amount of the 
section 481(a) adjustment of a co-producer relating to a particular JOA 
and for taking the section 481(a) adjustment into account. Paragraph 
(d)(5)(i)(B)(3) of this section provides rules for electing to take a 
co-producer's section 481(a) adjustment computed on an aggregate basis 
for all JOAs into account in the year of change. Paragraph (d)(5)(i)(C) 
of this section provides rules to coordinate the taking of a depletion 
deduction or a production credit with the inclusion of a section 481(a) 
adjustment arising from a change in method of accounting to the 
cumulative method under this paragraph (d)(5)(i).
    (2) Computation of the section 481(a) adjustment relating to a joint 
operating agreement--(i) In general. The section 481(a) adjustment of a 
co-producer relating to a JOA is computed as of the first day of the co-
producer's year of change and is equal to the difference between the 
amount of income reported under the co-producer's former method of 
accounting for all taxable years prior to the year of change and the 
amount of income that would have been reported if the co-producer's new 
method had been used in all those taxable years.
    (ii) Section 481(a) adjustment period. Except to the extent that 
paragraph (d)(5)(i)(B)(3) of this section applies, a co-producer's 
section 481(a) adjustment relating to a JOA, whether positive or 
negative, is taken into account in computing taxable income ratably over 
the 6-taxable-year period beginning with

[[Page 495]]

the year of change (the section 481(a) adjustment period). If the co-
producer has been in existence less than 6 taxable years, the adjustment 
is taken into account over the number of years the co-producer has been 
in existence. If the co-producer ceases to engage in the trade or 
business that gave rise to the section 481(a) adjustment at any time 
during the section 481(a) adjustment period, the entire remaining 
balance of the section 481(a) adjustment relating to that trade or 
business must be taken into account in the year of the cessation. For 
purposes of this paragraph (d)(5)(i)(B)(2)(ii), production under each 
JOA is treated as a separate trade or business. The determination as to 
whether the co-producer ceases to engage in its trade or business is to 
be made under the principles of Sec. 1.446--1(e)(3)(ii) and its 
underlying administrative procedures. For example, the permanent 
cessation of production under a co-producer's JOA constitutes the 
cessation of a trade or business of the co-producer. Accordingly, for 
the year that production under a JOA permanently ceases, the remaining 
balance of the section 481(a) adjustment relating to the JOA must be 
taken into account.
    (3) Election to take aggregate section 481(a) adjustment for all 
joint operating agreements into account in the year of change--(i) In 
general. A co-producer may elect to take into account its section 481(a) 
adjustment, computed on an aggregate basis for all of its JOAs, whether 
negative or positive, in the year of change, provided the co-producer 
uses the cumulative method for all of its JOAs entered into prior to its 
first taxable year beginning after December 31, 1994, and in effect as 
of the beginning of that year. The aggregate section 481(a) adjustment 
of a co-producer is equal to the difference between the amount of income 
reported under the co-producer's former method of accounting for all 
taxable years prior to the year of change and the amount of income that 
would have been reported if the co-producer's new method had been used 
in all of those taxable years for all JOAs for which the co-producer 
changes its method of accounting. An election made under this paragraph 
(d)(5)(i)(B)(3) is irrevocable. If any person who, together with another 
person, would be treated as a single taxpayer under section 41(f)(1) (A) 
or (B) makes an election under this paragraph (d)(5)(i)(B)(3), all 
persons within that single taxpayer group will be treated as if they had 
made an election under this paragraph (d)(5)(i)(B)(3) and, as such, will 
be irrevocably bound by that election. If a co-producer does not make an 
election under this paragraph, each JOA entered into prior to the start 
of its first taxable year beginning after December 31, 1994, and in 
effect as of the beginning of that year must be accounted for separately 
in computing the section 481(a) adjustment and taxable income of the co-
producer for any year to which this paragraph (d) applies.
    (ii) Time and manner for making the election. An election under this 
paragraph (d)(5)(i)(B)(3) is made by attaching a statement to the co-
producer's timely filed return for its year of change indicating that 
the co- producer is electing under Sec. 1.761-2(d)(5)(i)(B)(3) to take 
its aggregate section 481(a) adjustment into account in the year of 
change.
    (C) Treatment of section 481(a) adjustment as a sale for purposes of 
computing a production credit and as gross income from the property for 
purposes of depletion deductions. Any positive section 481(a) adjustment 
arising as a result of a change in method of accounting for gas 
imbalances under this paragraph (d)(5)(i) and taken into account in 
computing taxable income under paragraph (d)(5)(i)(B) of this section is 
considered a sale by the taxpayer for purposes of computing any 
production credit in the year that the adjustment is taken into account. 
Similarly, the positive section 481(a) adjustment is considered gross 
income from the property and taxable income from the property for 
purposes of computing depletion deductions in the year the adjustment is 
taken into account. Sales amounts used in computing any production 
credit in any year in which a negative section 481(a) adjustment is 
taken into account in computing taxable income under paragraph 
(d)(5)(i)(B) of this section must be reduced by the amount of the 
negative section 481(a) adjustment

[[Page 496]]

taken into account in that year. Similarly, gross income from the 
property and taxable income from the property used in computing any 
depletion deduction in any year in which the negative section 481(a) 
adjustment is taken into account must be reduced by the amount of the 
negative adjustment. For these purposes, any taxpayer that makes an 
aggregate section 481(a) adjustment election under paragraph 
(d)(5)(i)(B)(3) of this section must allocate the adjustment among its 
properties in any reasonable manner that prevents a duplication or 
omission of depletion deductions.
    (ii) Change in method of accounting to the annual method--(A) In 
general. A co-producer changing to the annual method in accordance with 
paragraph (d)(2)(ii) of this section must request a change under 
Sec. 1.446-1(e)(3) and will be subject to any terms and conditions as 
may be imposed by the Commissioner.
    (B) Section 481(a) adjustment. A change in method of accounting to 
the annual method is a change in method of accounting to which the 
provisions of section 481(a) apply. Thus, a section 481(a) adjustment 
must be taken into account to prevent the omission or duplication of 
income. If all the co-producers under a JOA have the same taxable year, 
the section 481(a) adjustment involved in a change to the annual method 
by a co-producer relating to the JOA is computed as of the first day of 
the co-producer's year of change. If the co-producers under a JOA do not 
all have the same taxable year (that is, in the case of a part-year 
change described in paragraph (d)(2)(ii)(C) of this section), the change 
in method of accounting occurs on January 1, 1996, and the section 
481(a) adjustment is computed on that date.
    (iii) Untimely change in method of accounting to comply with this 
section. Unless a co-producer required by this section to change its 
method of accounting complies with the provisions of this paragraph 
(d)(5) for its first applicable taxable year within the time prescribed 
by this paragraph (d)(5), the co-producer must take the section 481(a) 
adjustment into account under the provisions of any applicable 
administrative procedure that is prescribed by the Commissioner 
specifically for purposes of complying with this section. Absent such an 
administrative procedure, a co-producer must request a change under 
Sec. 1.446-1(e)(3) and will be subject to any terms and conditions as 
may be imposed by the Commissioner.
    (6) Examples. The following examples illustrate the application of 
the cumulative method described in paragraph (d)(3) of this section.

    Example 1. Operation of the cumulative method. (i) L, a corporation 
using the cash receipts and disbursements method of accounting, and M, a 
corporation using an accrual method, file returns on a calendar year 
basis. On January 1, 1995, L and M enter into a JOA to produce natural 
gas as an unincorporated organization from a reservoir located in State 
Y. The JOA allocates reservoir production 60 percent to L and 40 percent 
to M. L and M enter into a GBA as an addendum to the JOA. L and M agree 
to use the cumulative method to account for gas sales from the reservoir 
and elect under section 761(a) and this section to exclude the 
organization from the application of subchapter K. Production from the 
reservoir is eligible for the section 29 credit for producing fuel from 
a nonconventional source. L and M produce and sell the following amounts 
of natural gas (in mmcf) until 2000 during which year production from 
the reservoir ceases:

------------------------------------------------------------------------
                                 1995   1996   1997   1998   1999   2000
------------------------------------------------------------------------
L.............................    720    480    600    -0-    -0-    -0-
M.............................    240     60    120    160     80     40
------------------------------------------------------------------------

    (ii) By the end of 1996, neither L nor M has fully produced its 
percentage share of the total gas in the reservoir. In 1997, L produces 
a total of 600 mmcf of gas at the rate of 50 mmcf per month. Prior to 
filing its return for 1997, L determines that it fully produced its 
percentage share of gas in the reservoir as of June 30, 1997. Pursuant 
to the GBA executed by L and M, L pays M at the end of 2000 for the 300 
mmcf of M's gas (as determined under the cumulative method) that L sold 
in the last half of 1997.
    (iii) For 1995, L and M must include in their gross income the 
amounts relating to gas sales of 720 mmcf and 240 mmcf, respectively. 
For 1996, L and M must include the amounts relating to gas sales of 480 
mmcf and 60 mmcf, respectively. For both 1995 and 1996, L and M compute 
an allowance for depletion and a section 29 credit based upon gas taken 
and sold by each from the reservoir for each taxable year.
    (iv) For 1997, L and M must include in gross income the amounts 
relating to their gas sales of 600 mmcf and 120 mmcf, respectively. 
Under paragraph (d)(3)(iii)(A) of this section, L computes an allowance 
for depletion and

[[Page 497]]

the section 29 credit based only on production from L's proportionate 
share of gas in the reservoir (that is, based on L's production through 
June 30, 1997). Accordingly, for 1997, L claims depletion and the 
section 29 credit only with respect to 300 mmcf of gas (50 mmcf per 
month x 6 months). For 1997, because M has not fully produced from its 
percentage share of the total gas in the reservoir as of the end of 
1997, M claims depletion and the section 29 credit on the 120 mmcf that 
M produced in 1997.
    (v) In 1998 and 1999, M must include in gross income the amounts 
relating to M's sales of gas, that is, 160 mmcf for 1998 and 80 mmcf for 
1999. For 2000, M must include in gross income the amount relating to 
sales of 340 mmcf of gas, which consists of its own sales of 40 mmcf 
plus the payment for 300 mmcf of gas that L made to M for having sold 
from M's share of the total gas in the reservoir during the last half of 
1997. Because M produced from its percentage share of the total gas in 
the reservoir during 1998, 1999, and 2000, M claims a depletion 
deduction and a section 29 credit on its income and production for those 
years, that is, 160 mmcf for 1998, 80 mmcf for 1999, and 40 mmcf for 
2000. Additionally, for 2000, M claims depletion and the section 29 
credit relating to the payment that M received from L for the 300 mmcf 
of M's gas that L sold in the last half of 1997. Under paragraph 
(d)(3)(ii)(B) of this section, L's deduction for its payment to M for 
the 300 mmcf of M's gas that L sold in 1997 is allowable only for 2000.
    Example 2. Adjustments under the cumulative method for depletion 
deductions and production credits that were claimed for sales in excess 
of a co-producer's percentage share of total gas in the reservoir. (i) 
L, a corporation using the cash receipts and disbursements method of 
accounting, and M, a corporation using an accrual method, file returns 
on a calendar year basis. On January 1, 1995, L and M enter into a JOA 
to produce natural gas as an unincorporated organization from a 
reservoir located in State Y. The JOA allocates reservoir production 60 
percent to L and 40 percent to M. L and M enter into a GBA as an 
addendum to the JOA. L and M agree to use the cumulative method to 
account for gas sales from the reservoir and elect under section 761(a) 
and this section to exclude the organization from the application of 
subchapter K. Production from the reservoir is eligible for the section 
29 credit for producing fuel from a nonconventional source. L and M 
produce and sell the following amounts of natural gas (in mmcf) until 
2000 during which year production from the reservoir ceases:

------------------------------------------------------------------------
                                 1995   1996   1997   1998   1999   2000
------------------------------------------------------------------------
L.............................    720    480    600     60     60    -0-
M.............................    240     60    120     60     60     40
------------------------------------------------------------------------

    (ii) In addition, L does not realize until December 31, 1999, that L 
fully produced its percentage share of the total gas in the reservoir as 
of June 30, 1997. At the time of filing its returns for 1997 and 1998, L 
reasonably believes that during 1997 and 1998, respectively, it did not 
fully produce its percentage share of the total gas in the reservoir. 
Thus, L claims depletion and the section 29 credit for its total sales 
of 600 mmcf in 1997 and 60 mmcf in 1998. Pursuant to the GBA executed by 
L and M, L pays M at the end of 2000 for the 420 mmcf of M's gas (as 
determined under the cumulative method) that L sold (300 mmcf in the 
last half of 1997 (assuming that production was at a rate of 50 mmcf per 
month), 60 mmcf in 1998, and 60 mmcf in 1999).
    (iii) In 1997 and 1998, L and M include in gross income the amounts 
relating to their respective sales of gas, that is, for L 600 mmcf for 
1997 and 60 mmcf for 1998, and for M 120 mmcf for 1997 and 60 mmcf for 
1998.
    (iv) For 1999, L must include in gross income the amount of its 
sales of 60 mmcf, but may not claim depletion or the section 29 credit 
on those sales. For 1999, M must include in gross income the amount of 
its sales of 60 mmcf and claims depletion and the section 29 credit with 
respect to those 60 mmcf.
    (v) For 2000, M must include in gross income the amount relating to 
gas sales of 460 mmcf, that is, the amount of M's own gas sales of 40 
mmcf and the amount of the payment received from L for the 420 mmcf of 
M's gas that L sold (consisting of 300 mmcf in 1997, 60 mmcf in 1998, 
and 60 mmcf in 1999). Under paragraph (d)(3)(iii)(A) of this section, M 
computes a depletion deduction and a production credit relating to the 
amount of M's actual gas sales for 2000 and the payment received from L, 
that is, relating to a total of 460 mmcf of gas (M's sales of 40 mmcf 
for 2000, plus L's payment for 420 mmcf of gas). Under paragraph 
(d)(3)(ii)(B) of this section, L's deduction for making its payment to M 
for 420 mmcf of gas is allowable only for 2000. Under paragraph 
(d)(3)(iii)(B) of this section, L must reduce its deduction by the 
amount of any percentage depletion deductions allowed on its sales of 
M's gas, that is, relating to 360 mmcf of gas (300 mmcf for 1997 and 60 
mmcf for 1998). In addition, under paragraph (d)(3)(iii)(C) of this 
section, L must increase its tax for 2000 by the amount of any section 
29 credit L claimed on its sales of M's gas, but only to the extent that 
the credit claimed actually reduced L's tax in any earlier year.
    Example 3. Non-abusive altering of the taking of production for a 
taxable year. (i) C and D enter into a JOA and a GBA on December 1, 
1994, for gas production from a reservoir. The

[[Page 498]]

JOA allocates production at 50 percent to C and 50 percent to D. C and D 
agree in writing to use the cumulative method to account for gas sales. 
Additionally, C and D elect under section 761(a) and this section to 
exclude their organization from the application of subchapter K. C and D 
arrange to sell all their production under annually renewable contracts. 
In 1995, C and D each sell 480 mmcf of gas from the reservoir.
    (ii) In November 1995, D is notified that its contract with its 
purchaser will not be renewed for 1996. D is unable to find a new 
purchaser for its gas for 1996. In December 1995, D notifies C that it 
will not be taking production from the reservoir in 1996. Pursuant to 
the GBA, C then contracts with its current gas purchaser to sell an 
additional 20 mmcf per month in 1996. Accordingly, C sells 720 mmcf in 
1996 (60 mmcf per month x 12 months). Under the facts described in this 
example, a principal purpose of altering the taking of production is not 
to avoid tax. Accordingly, the co-producers' election under section 
761(a) will not be revoked by reason of altering the taking of 
production.
    Example 4. Abusive altering of the taking of production for a 
taxable year. The facts are the same as in Example 3(i). For 1996, C 
anticipates that C's regular tax (reduced by the credits allowable under 
sections 27 and 28) will not exceed C's tentative minimum tax. 
Accordingly, under section 29(b)(6), C's credit allowed under section 
29(a) for sales of its gas will be zero. For 1997, C anticipates that 
its credit allowed under section 29(a) will not be limited by section 
29(b)(6). On the other hand, D anticipates that any credit it may claim 
under section 29(a) for 1996, even including a credit based on sales of 
C's share of current production under the JOA, will not be limited by 
section 29(b)(6). However, for 1997, D anticipates that its credit under 
section 29(a) will be limited by section 29(b)(6). On January 1, 1996, C 
and D agree that D will contract with its purchaser to sell the entire 
960 mmcf produced from the reservoir in 1996 and that C will contract 
with its purchaser to sell the entire 960 mmcf produced from the 
reservoir in 1997. Under these facts, a principal purpose of altering 
the taking of production is to avoid tax. Accordingly, the co-producers' 
election under section 761(a) will be revoked for 1996 and for 
subsequent years.

    (7) Effective date. Except in the case of a part-year change to the 
annual method or the cessation of a JOA, both of which are described in 
paragraph (d)(2)(ii)(C) of this section, the provisions of this 
paragraph (d) apply to all taxable years beginning after December 31, 
1994, of any producer that is a member of an unincorporated organization 
that produces natural gas under a JOA in effect on or after the start of 
the producer's first taxable year beginning after December 31, 1994. In 
the case of a part-year change, the provisions of this paragraph (d) 
apply on and after January 1, 1996. In the case of the cessation of a 
JOA, the co-producers use their current method of accounting with 
respect to that JOA until the JOA ceases to be in effect.
    (e) Cross reference. For requirements with respect to the filing of 
a return on Form 1065 by a partnership, see Sec. 1.6031-1.

[T.D. 7208, 37 FR 20687, Oct. 3, 1972; 37 FR 23161, Oct. 31, 1972, as 
amended by T.D. 8578, 59 FR 66183, Dec. 23, 1994; 60 FR 11028, Mar. 1, 
1995]

         Effective Date for Subchapter K, Chapter 1 of the Code



Sec. 1.771-1   Effective date.

    (a) General rule. Except as provided in paragraph (b) or (c) of this 
section, the provisions of subchapter K, chapter 1 of the Code, shall 
apply to any taxable year of a partnership beginning after December 31, 
1954, and to any part of a partner's taxable year falling within such 
partnership taxable year. The provisions of the Internal Revenue Code of 
1939 relating to partnerships shall apply to any taxable year of a 
partnership beginning before January 1, 1955, and to any part of a 
partner's taxable year falling within such partnership taxable year. If 
a partnership and the partners are on different taxable years, 
subchapter K shall become effective at the same time both for the 
partnership and for the partners.
    (b) Special rules. Certain provisions of section 771 apply after 
specific dates in 1954, as follows:
    (1) Adoption of taxable year. Section 706(b) (relating to the 
adoption of taxable years by partners and partnerships), shall apply to 
any partnership which adopts or changes to, and any partner who changes 
to, a taxable year beginning on or after April 2, 1954. For the purpose 
of applying this subparagraph, the rules of section 708 (relating to the 
continuation of partnerships) shall apply. For example, if two or more 
partnerships merge after April 1, 1954, and the new partnership uses the 
taxable year of the partnership of which it is deemed to be the 
successor

[[Page 499]]

under section 708(b)(2)(A), it will not need prior approval to continue 
to use such taxable year even though such year may be different from the 
taxable years of the partners. Such a partnership is not ``adopting'' or 
``changing'' its taxable year.
    (2) Property distributed by a partnership. Section 735(a), relating 
to the character of gain or loss on disposition of property distributed 
by a partnership to a partner, shall apply only to property distributed 
after March 9, 1954. Although a partnership whose taxable year begins 
before January 1, 1955, generally will be subject to the provisions of 
the Internal Revenue Code of 1939, any unrealized receivables or 
inventory items distributed by any such partnership after March 9, 1954, 
will be subject to the provisions of section 735(a), and the gain or 
loss on the subsequent disposition of such property will be ordinary 
gain or loss rather than capital gain or loss. In the case of property 
distributed before March 10, 1954, section 735(a) will not apply, even 
though the property is disposed of by the distributee partner after that 
date, unless the partnership elects under paragraph (c) of this section 
to apply section 735.
    (3) Unrealized receivables and inventory items. Section 751 
(providing for the realization of ordinary income on certain transfers 
or distributions of unrealized receivables or substantially appreciated 
inventory items) shall be applicable to any such transfer or 
distribution occurring after March 9, 1954. For the purpose of applying 
section 751 in the case of a taxable year beginning before January 1, 
1955, a partnership or partner may elect to treat as applicable any 
other section of subchapter K. See paragraph (f) of Sec. 1.751-1.
    (4) Partner receiving income in respect of a decedent. Section 753, 
which provides that the amount includible in the gross income of a 
successor in interest of a deceased partner under section 736(a) shall 
be considered income in respect of a decedent under section 691, shall 
apply only in the case of payments made with respect to decedents whose 
death occurred after December 31, 1954.
    (c) Optional treatment of certain distributions. (1) For a 
partnership taxable year beginning after December 31, 1953, and before 
January 1, 1955, a partnership may elect to apply the rules of certain 
sections of subchapter K with respect to current distributions made by 
the partnership in such year. These sections are 731, 732 (a), (c), and 
(e), 733, 735, and 751 (b), (c), and (d). If an election is made, it 
shall apply to the partnership and all its members for all current 
distributions made by the partnership during the taxable year. Such 
distributions shall also be subject to the rules of section 705 
(relating to determination of basis of a partner's interest), 752 
(relating to treatment of certain liabilities), and 761(d) (relating to 
the definition of liquidation of a partner's interest), to the extent 
that such sections apply to current distributions.
    (2) An election under this paragraph shall be made by a statement 
filed with the partnership return for the taxable year to which such 
election applies, or before August 23, 1956, whichever date is later. 
The statement shall be signed by all members of the partnership and the 
election once made shall be binding on the partnership and on all of its 
members.

                           INSURANCE COMPANIES

                        Life Insurance Companies

                         definition; tax imposed



Sec. 1.801-1   Definitions.

    (a) Life insurance company. The term life insurance company as used 
in subtitle A of the Code is defined in section 801. For the purpose of 
determining whether a company is a ``life insurance company'' within the 
meaning of that term as used in section 801, it must first be determined 
whether the company is taxable as an insurance company under the Code. 
For the definition of an ``insurance company'', see paragraph (b) of 
this section. In determining whether an insurance company is a life 
insurance company, the life insurance reserves (as defined in section 
803(b)) plus any unearned premiums and unpaid losses on noncancellable 
life, health, or accident policies, not included in ``life insurance 
reserves'' must comprise more than 50 percent of its total reserves (as 
defined in section 801). An insurance company writing

[[Page 500]]

only noncancellable life, health, or accident policies and having no 
``life insurance reserves'' may qualify as a life insurance company if 
its unearned premiums and unpaid losses on such policies comprise more 
than 50 percent of its total reserves. A noncancellable insurance policy 
means a contract which the insurance company is under an obligation to 
renew or continue at a specified premium and with respect to which a 
reserve in addition to the unearned premium must be carried to cover 
that obligation. For the purpose of the preceding sentence, the term 
``unearned premium'' means the amount which will cover the cost of 
carrying the insurance risk for the period for which the premium has 
been paid in advance. A burial or funeral benefit insurance company 
qualifying as a life insurance company engaged directly in the 
manufacture of funeral supplies or the performance of funeral services 
will be taxable under section 821 or section 831 as an insurance company 
other than life.
    (b) Insurance companies. (1) Insurance companies include both stock 
and mutual companies, as well as mutual benefit insurance companies. A 
voluntary unincorporated association of employees formed for the purpose 
of relieving sick and aged members and the dependents of deceased 
members is an insurance company, whether the fund for such purpose is 
created wholly by membership dues or partly by contributions from the 
employer. A corporation which merely sets aside a fund for the insurance 
of its employees is not required to file a separate return for such 
fund, but the income therefrom shall be included in the return of the 
corporation.
    (2) Though its name, charter powers, and subjection to State 
insurance laws are significant in determining the business which a 
corporation is authorized and intends to carry on, the character of the 
business actually done in the taxable year determines whether it is 
taxable as an insurance company under the Code. For example, during the 
year 1954 the M Corporation, incorporated under the insurance laws of 
the State of R, carried on the business of lending money in addition to 
guaranteeing the payment of principal and interest of mortgage loans. Of 
its total income for the year, one-third was derived from its insurance 
business of guaranteeing the payment of principal and interest of 
mortgage loans and two-thirds was derived from its noninsurance business 
of lending money. The M Corporation is not an insurance company for the 
year 1954 within the meaning of the Code and the regulations thereunder.



Sec. 1.801-2   Taxable years affected.

    Section 1.801-1 is applicable only to taxable years beginning after 
December 31, 1953, and before January 1, 1955, and all references to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.801-3 
through 1.801-7 are applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112). Section 1.801-8 is applicable only to taxable years beginning 
after December 31, 1961, and all references to sections of part I, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, as amended by the Life Insurance Company Income Tax Act of 1959 
(73 Stat. 112) and section 3 of the Act of October 23, 1962 (76 Stat. 
1134).

[T.D. 6886, 31 FR 8681, June 23, 1966]



Sec. 1.801-3   Definitions.

    For purposes of part I, subchapter L, chapter 1 of the Code, this 
section defines the following terms, which are to be used in determining 
if a taxpayer is a life insurance company (as defined in section 801(a) 
and paragraph (b) of this section):
    (a) Insurance company. (1) The term insurance company means a 
company whose primary and predominant business activity during the 
taxable year is the issuing of insurance or annuity contracts or the 
reinsuring of risks underwritten by insurance companies. Thus, though 
its name, charter powers, and subjection to State insurance laws are 
significant in determining the business which a company is authorized 
and intends to carry on, it is the character of the business actually 
done in

[[Page 501]]

the taxable year which determines whether a company is taxable as an 
insurance company under the Internal Revenue Code.
    (2) Insurance companies include both stock and mutual companies, as 
well as mutual benefit insurance companies. For taxable years beginning 
before January 1, 1970, a voluntary unincorporated association of 
employees, including an association fulfilling the requirements of 
section 801(b)(2)(B) (as in effect for such years), formed for the 
purpose of relieving sick and aged members and the dependents of 
deceased members, is an insurance company, whether the fund for such 
purpose is created wholly by membership dues or partly by contributions 
from the employer. A corporation which merely sets aside a fund for the 
insurance of its employees is not an insurance company, and the income 
from such fund shall be included in the return of the corporation.
    (b) Life insurance company. (1) The term life insurance company, as 
used in subtitle A of the Code, is defined in section 801(a). For the 
purpose of determining whether a company is a ``life insurance company'' 
within the meaning of that term as used in section 801(a), it must first 
be determined whether the company is taxable as an insurance company (as 
defined in paragraph (a) of this section). An insurance company shall be 
taxed as a life insurance company if it is engaged in the business of 
issuing life insurance and annuity contracts (either separately or 
combined with health and accident insurance), or noncancellable 
contracts of health and accident insurance, and its life insurance 
reserves (as defined in section 801(b) and Sec. 1.801-4), plus unearned 
premiums, and unpaid losses (whether or not ascertained), on 
noncancellable life, health, or accident policies not included in life 
insurance reserves, comprise more than 50 percent of its total reserves 
(as defined in section 801(c) and Sec. 1.801-5). For purposes of 
determining whether it satisfies the percentage requirements of the 
preceding sentence, a company shall first make any adjustments to life 
insurance reserves and total reserves required by section 806(a) 
(relating to adjustments for certain changes in reserves and assets) and 
then as required by section 801(d) (relating to adjustments in reserves 
for policy loans). For examples of the adjustments required under 
section 806(a), see paragraph (b)(4) of Sec. 1.806-3. For an example of 
the adjustments required under section 801(d), see paragraph (c) of 
Sec. 1.801-6. Furthermore, if an insurance company which computes its 
life insurance reserves on a preliminary term basis elects to revalue 
such reserves on a net level premium basis under section 818(c), such 
revalued basis shall be disregarded for purposes of section 801.
    (2) An insurance company writing only noncancellable life, health, 
or accident policies and having no ``life insurance reserves'' may 
qualify as a life insurance company if its unearned premiums, and unpaid 
losses (whether or not ascertained), on such policies comprise more than 
50 percent of its total reserves.
    (3) Section 801(f) provides that a burial or funeral benefit 
insurance company engaged directly in the manufacture of funeral 
supplies or the performance of funeral services shall not be taxable 
under section 802 but shall be taxable under section 821 or section 831 
as an insurance company other than life.
    (c) Noncancellable life, health, or accident insurance policy. The 
term noncancellable life, health, or accident insurance policy means a 
health and accident contract, or a health and accident contract combined 
with a life insurance or annuity contract, which the insurance company 
is under an obligation to renew or continue at a specified premium and 
with respect to which a reserve in addition to the unearned premiums (as 
defined in paragraph (e) of this section) must be carried to cover that 
obligation. Such a health and accident contract shall be considered 
noncancellable even though it states a termination date at a stipulated 
age, if, with respect to the health and accident contract, such age 
termination date is 60 or over. Such a contract, however, shall not be 
considered to be noncancellable after the age termination date 
stipulated in the contract has passed. However, if the age termination 
date stipulated in the contract occurs during the period covered

[[Page 502]]

by a premium received by the life insurance company prior to such date, 
and the company cannot cancel or modify the contract during such period, 
the age termination date shall be deemed to occur at the expiration of 
the period for which the premium has been received.
    (d) Guaranteed renewable life, health, and accident insurance 
policy. The term guaranteed renewable life, health, and accident 
insurance policy means a health and accident contract, or a health and 
accident contract combined with a life insurance or annuity contract, 
which is not cancellable by the company but under which the company 
reserves the right to adjust premium rates by classes in accordance with 
its experience under the type of policy involved, and with respect to 
which a reserve in addition to the unearned premiums (as defined in 
paragraph (e) of this section) must be carried to cover that obligation. 
Section 801(e) provides that such policies shall be treated in the same 
manner as noncancellable life, health, and accident insurance policies. 
For example, the age termination date requirements applicable to 
noncancellable health and accident insurance policies shall also apply 
to guaranteed renewable life, health, and accident insurance policies. 
See paragraph (c) of this section.
    (e) Unearned premiums. The term unearned premiums means those 
amounts which shall cover the cost of carrying the insurance risk for 
the period for which the premiums have been paid in advance. Such term 
includes all unearned premiums, whether or not required by law.
    (f) Life insurance reserves. For the definition of the term ``life 
insurance reserves'', see section 801(b) and Sec. 1.801-4.
    (g) Unpaid losses (whether or not ascertained). The term unpaid 
losses (whether or not ascertained) means a reasonable estimate of the 
amount of the losses (based upon the facts in each case and the 
company's experience with similar cases):
    (1) Reported and ascertained by the end of the taxable year but 
where the amount of the loss has not been paid by the end of the taxable 
year,
    (2) Reported by the end of the taxable year but where the amount 
thereof has not been either ascertained or paid by the end of the 
taxable year, or
    (3) Which have occurred by the end of the taxable year but which 
have not been reported or paid by the end of the taxable year.
    (h) Total reserves. For the definition of the term total reserves, 
see section 801(c) and Sec. 1.801-5.
    (i) Amount of reserves. For purposes of subsections (a), (b), and 
(c) of section 801 and this section, section 801(b)(5) provides that the 
amount of any reserve (or portion thereof) for any taxable year shall be 
the mean of such reserve (or portion thereof) at the beginning and end 
of the taxable year.

[T.D. 6513, 25 FR 12655, Dec. 10, 1960, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.801-4   Life insurance reserves.

    (a) Life insurance reserves defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, the term life insurance reserves 
(as defined in section 801(b)) means those amounts:
    (1) Which are computed or estimated on the basis of recognized 
mortality or morbidity tables and assumed rates of interest;
    (2) Which are set aside to mature or liquidate, either by payment or 
reinsurance, future unaccrued claims arising from life insurance, 
annuity, and noncancellable health and accident insurance contracts 
(including life insurance or annuity contracts combined with 
noncancellable health and accident insurance) involving, at the time 
with respect to which the reserve is computed, life, health, or accident 
contingencies; and
    (3) Which, except as otherwise provided by section 801(b)(2) and 
paragraphs (b) and (c) of this section, are required by law. For the 
meaning of the term ``reserves required by law'', see paragraph (b) of 
Sec. 1.801-5.

For purposes of determining life insurance reserves, only those amounts 
shall be taken into account which must be reserved either by express 
statutory provisions or by rules and regulations of the insurance 
department of a State, Territory, or the District of Columbia when 
promulgated in the exercise of a power conferred by statute. Moreover,

[[Page 503]]

such amounts must actually be held by the company during the taxable 
year for which the reserve is claimed. However, reserves held by the 
company with respect to the net value of risks reinsured in other 
solvent companies (whether or not authorized) shall be deducted from the 
company's life insurance reserves. For example, if an ordinary life 
policy with a reserve of $100 is reinsured in another solvent company on 
a yearly renewable term basis, and the reserve on such yearly renewable 
term policy is $10, the reinsured company shall include $90 ($100 minus 
$10) in determining its life insurance reserves. Generally, life 
insurance reserves, as in the case of level premium life insurance, are 
held to supplement the future premium receipts when the latter, alone, 
are insufficient to cover the increased risk in the later years. For 
examples of reserves which qualify as life insurance reserves, see 
paragraph (d) of this section. For examples of reserves which do not 
qualify as life insurance reserves, see paragraph (e) of this section.
    (b) Certain reserves which need not be required by law. Section 
801(b)(2) sets forth certain reserves which, though not required by law, 
may still qualify as life insurance reserves, provided, however, that 
they first satisfy the requirements of section 801(b)(1) (A) and (B) and 
paragraph (a) (1) and (2) of this section. Thus, reserves need not be 
required by law:
    (1) In the case of policies covering life, health, and accident 
insurance combined in one policy issued on the weekly premium payment 
plan, continuing for life and not subject to cancellation, and
    (2) For taxable years beginning before January 1, 1970, in the case 
of policies issued by an organization which met the requirements of 
section 501(c)(9) (as it existed prior to amendment by the Tax Reform 
Act of 1969) other than the requirement of subparagraph (B) thereof.
    (c) Assessment companies. Section 801(b)(3) provides that in the 
case of an assessment life insurance company or association, the term 
life insurance reserves includes:
    (1) Sums actually deposited by such company or association with 
officers of a State or Territory pursuant to law as guaranty or reserve 
funds, and
    (2) Any funds maintained, under the charter or articles of 
incorporation or association of such company or association (or bylaws 
approved by the State insurance commissioner) of such company or 
association, exclusively for the payment of claims arising under 
certificates of membership or policies issued upon the assessment plan 
and not subject to any other use.

For purposes of part I, subchapter L, chapter 1 of the Code, the 
reserves described in this paragraph shall be included as life insurance 
reserves even though such reserves do not meet the requirements of 
section 801(b) and paragraph (a) of this section. However, for such 
reserves to be included as life insurance reserves, they must be 
deposited or maintained to liquidate future unaccrued claims arising 
from life insurance, annuity, or noncancellable health and accident 
insurance contracts (including life insurance or annuity contracts 
combined with noncancellable health and accident insurance) involving, 
at the time with respect to which the reserve is deposited or 
maintained, life, health, or accident contingencies. The rate of 
interest assumed in calculating the reserves described in this paragraph 
shall be 3 percent, regardless of the rate of interest (if any) 
specified in the contract in respect of such reserves.
    (d) Reserves which qualify as life insurance reserves. The following 
reserves, provided they meet the requirements of section 801(b) and 
paragraph (a) of this section, are illustrative of reserves which shall 
be included as life insurance reserves:
    (1) Reserves held under life insurance contracts.
    (2) Reserves held under annuity contracts (including reserves held 
under variable annuity contracts as described in section 801(g)(1)).
    (3) Reserves held under noncancellable health and accident insurance 
contracts (as defined in paragraph (c) of Sec. 1.801-3) and reserves 
held under guaranteed renewable health and accident insurance contracts 
(as defined in paragraph (d) of Sec. 1.801-3).
    (4) Reserves held either separately or combined under contracts 
described in

[[Page 504]]

subparagraphs (1), (2), or (3) of this paragraph.
    (5) Reserves held under deposit administration contracts. Generally, 
the reserves held by a life insurance company on both the active and 
retired lives under deposit administration contracts will meet the 
requirements of section 801(b) and paragraph (a) of this section.

However, reserves held by the company with respect to the net value of 
risks reinsured in other solvent companies (whether or not authorized) 
shall be deducted from the company's life insurance reserves. See 
paragraph (a) of this section.
    (e) Reserves and liabilities which do not qualify as life insurance 
reserves. The following are illustrative of reserves and liabilities 
which do not meet the requirements of section 801(b) and paragraph (a) 
of this section and, accordingly, shall not be included as life 
insurance reserves:
    (1) Liability for supplementary contracts not involving at the time 
with respect to which the liability is computed, life, health, or 
accident contingencies.
    (2) In the case of cancellable health and accident policies and 
similar cancellable contracts, the unearned premiums and unpaid losses 
(whether or not ascertained).
    (3) The unearned premiums, and unpaid losses (whether or not 
ascertained), on noncancellable life, health, or accident policies (and 
guaranteed renewable life, health, and accident policies) not included 
in life insurance reserves. (However, such amounts shall be taken into 
account under section 801(a)(2) for purposes of determining whether an 
insurance company is a life insurance company.)
    (4) The deficiency reserve (as defined in section 801(b)(4)) for 
each individual contract, that is, that portion of the reserve for such 
contract equal to the amount (if any) by which:
    (i) The present value of the future net premiums required for such 
contract, exceeds
    (ii) The present value of the future actual premiums and 
consideration charged for such contract.
    (5) Reserves required to be maintained to provide for the ordinary 
operating expenses of a business which must be currently paid by every 
company from its income if its business is to continue, such as taxes, 
salaries, and unpaid brokerage.
    (6) Liability for premiums received in advance.
    (7) Liability for premium deposit funds.
    (8) Liability for annual and deferred dividends declared or 
apportioned.
    (9) Liability for dividends left on deposit at interest.
    (10) Liability for accrued but unsettled policy claims whether known 
or unreported.
    (11) A mandatory securities valuation reserve.
    (f) Adjustments to life insurance reserves. In the event it is 
determined on the basis of the facts of a particular case that premiums 
deferred and uncollected and premiums due and unpaid are not properly 
accruable for the taxable year under section 809 and, accordingly, are 
not properly includible under assets (as defined in section 805(b)(4)) 
for the taxable year, appropriate reduction shall be made in the life 
insurance reserves. This reduction shall be made when the insurance 
company has calculated life insurance reserves on the assumption that 
the premiums on all policies are paid annually or that all premiums due 
on or prior to the date of the annual statement have been paid.

[T.D. 6513, 25 FR 12656, Dec. 10, 1960, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.801-5   Total reserves.

    (a) Total reserves defined. For purposes of section 801(a) and 
Sec. 1.801-3, the term ``total reserves'' is defined in section 801(c) 
as the sum of:
    (1) Life insurance reserves (as defined in section 801(b) and 
Sec. 1.801-4),
    (2) Unearned premiums (as defined in paragraph (e) of Sec. 1.801-3), 
and unpaid losses (whether or not ascertained) (as defined in paragraph 
(g) of Sec. 1.801-3), not included in life insurance reserves, and
    (3) All other insurance reserves required by law.

The term ``total reserves'' does not, however, include deficiency 
reserves (within the meaning of section 801(b)(4), and paragraph (e)(4) 
of Sec. 1.801-

[[Page 505]]

4), even though such deficiency reserves are required by State law. In 
determining total reserves, a company is permitted to make use of the 
highest aggregate reserve required by any State or Territory or the 
District of Columbia in which it transacts business, but the reserve 
must have been actually held during the taxable year for which the 
reserve is claimed. For example, during the taxable year 1958 a life 
insurance company sells life insurance and annuity contracts in States A 
and B. State A requires reserves of 10 against the life and 5 against 
the annuity business. State B requires reserves of 9 against the life 
and 7 against the annuity business. Assuming the company actually holds 
these reserves during the taxable year 1958, its highest aggregate 
reserve for such taxable year is the 16 required by State B. Thus, the 
company is not permitted to compute its highest aggregate reserve by 
taking State A's requirement of 10 against its life insurance business 
and adding it to State B's requirement of 7 against its annuity 
business.
    (b) Reserves required by law defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, the term reserves required by law 
means reserves which are required either by express statutory provisions 
or by rules and regulations of the insurance department of a State, 
Territory, or the District of Columbia when promulgated in the exercise 
of a power conferred by statute, and which are reported in the annual 
statement of the company and accepted by state regulatory authorities as 
held for the fulfillment of the claims of policyholders or 
beneficiaries.
    (c) Information to be filed. In any case where reserves are claimed, 
sufficient information must be filed with the return to enable the 
district director to determine the validity of the claim. See section 
6012 and paragraph (c) of Sec. 1.6012-2. If the basis (for Federal 
income tax purposes) for determining the amount of any of the life 
insurance reserves as of the close of the taxable year differs from the 
basis for such determination as of the beginning of the taxable year 
then the following information must be filed with respect to all such 
changes in basis:
    (1) The nature of the life insurance reserve (i.e., life, annuity, 
etc.);
    (2) The mortality or morbidity table, assumed rate of interest, 
method used in computing or estimating such reserve on the old basis, 
and the amount of such reserve at the beginning and close of the taxable 
year computed on the old basis;
    (3) The mortality or morbidity table, assumed rate of interest, 
method used in computing or estimating such reserve on the new basis, 
and the amount of such reserve at the close of the taxable year computed 
on the new basis;
    (4) The deviation, if any, from recognized mortality or morbidity 
tables, or recognized methods of computation;
    (5) The reasons for the change in basis of such reserve; and
    (6) Whether such change in the reserve has been approved or accepted 
by the regulatory authorities of the State of domicile, and if so, a 
copy of the letter, certificate, or other evidence of such approval or 
acceptance.
    (d) Illustration of principles. The provisions of section 801 
relating to the percentage requirements for qualification as a life 
insurance company may be illustrated by the following example:

    Example. The books of Y, an insurance company, selling life 
insurance, noncancellable health and accident insurance, and cancellable 
accident and health insurance, reflect (after adjustment under sections 
806(a) and 801(d)) the following facts for the taxable year 1958:

------------------------------------------------------------------------
                                                                 Mean of
                                                Jan. 1  Dec. 31    year 
------------------------------------------------------------------------
1. Life insurance reserves...................   $3,000   $5,000   $4,000
2. Unearned premiums, and unpaid losses                                 
 (whether or not ascertained), on                                       
 noncancellable accident and health insurance                           
 not included in life insurance reserves.....      400      600      500
3. Unearned premiums, and unpaid losses                                 
 (whether or not ascertained), on cancellable                           
 accident and health insurance...............    1,800    2,200    2,000
4. All other insurance reserves required by                             
 law.........................................      900    1,100    1,000
                                              --------------------------
5. Total reserves............................  .......  .......    7,500
------------------------------------------------------------------------


[[Page 506]]

The rules provided by section 801 require that the sum of the mean of 
the year figures in items 1 and 2 comprise more than 50 percent of the 
mean of the year figure in item 5 for an insurance company to qualify as 
a life insurance company. Thus, Y would qualify as a life insurance 
company for the taxable year 1958 as the sum of the mean of the year 
figures in items 1 and 2 ($4,500) comprise 60 percent of the mean of the 
year figure in item 5 ($7,500).

[T.D. 6513, 25 FR 12657, Dec. 10, 1960]



Sec. 1.801-6   Adjustments in reserves for policy loans.

    (a) In general. Section 801(d) provides that for purposes only of 
determining whether or not an insurance company is a life insurance 
company (as defined in section 801(a) and paragraph (b) of Sec. 1.801-
3), the life insurance reserves (as defined in section 801(b) and 
Sec. 1.801-4), and the total reserves (as defined in section 801(c) and 
paragraph (a) of Sec. 1.801-5), shall each be reduced by an amount equal 
to the mean of the aggregates, at the beginning and end of the taxable 
year, of the policy loans outstanding with respect to contracts for 
which life insurance reserves are maintained. Such reduction shall be 
made after any adjustments required under section 806(a) and Sec. 1.806-
3 have been made.
    (b) Policy loans defined. The term policy loans includes loans made 
by the insurance company, by whatever name called, for which the reserve 
on a contract is the collateral.
    (c) Illustration of principles. The provisions of section 801(d) and 
this section may be illustrated by the following example:

    Example. The books of T, an insurance company, selling only life 
insurance and cancellable accident and health insurance, reflect (after 
adjustment under section 806 (a)) the following facts for the taxable 
year 1958:

------------------------------------------------------------------------
                                                                 Mean of
                                                Jan. 1  Dec. 31    year 
------------------------------------------------------------------------
1. Life insurance reserves...................   $1,000   $2,000   $1,500
2. Policy loans..............................       50      850      450
                                              --------------------------
3. Life insurance reserves less policy loans.  .......  .......    1,050
4. Unearned premiums, and unpaid losses                                 
 (whether or not ascertained), on cancellable                           
 accident and health insurance...............      900    1,600    1,250
                                              --------------------------
5. Total reserves adjusted for policy loans                             
 (item 3 plus item 4)........................  .......  .......    2,300
------------------------------------------------------------------------

As the rules provided by section 801 (a) and (d) require that the figure 
in item 3 ($1,050) be more than 50 percent of the mean of the year 
figure in item 5 ($2,300) for an insurance company to qualify as a life 
insurance company, T would not qualify as a life insurance company for 
the taxable year 1958.

[T.D. 6513, 25 FR 12657, Dec. 10, 1960]



Sec. 1.801-7   Variable annuities.

    (a) In general. (1) Section 801(g)(1) provides that for purposes of 
part I, subchapter L, chapter 1 of the Code, an annuity contract 
includes a contract which provides for the payment of a variable annuity 
computed on the basis of recognized mortality tables and the investment 
experience of the company issuing such a contract. A variable annuity 
differs from the ordinary or fixed dollar annuity in that the annuity 
benefits payable under a variable annuity contract vary with the 
insurance company's investment experience with respect to such contracts 
while the annuity benefits paid under a fixed dollar annuity contract 
are guaranteed irrespective of the company's actual investment earnings.
    (2) The reserves held with respect to the annuity contracts 
described in section 801(g)(1) and subparagraph (1) of this paragraph 
shall qualify as life insurance reserves within the meaning of section 
801(b)(1) and paragraph (a) of Sec. 1.801-4 provided such reserves are 
required by law (as defined in paragraph (b) of Sec. 1.801-5) and are 
set aside to mature or liquidate, either by payment or reinsurance, 
future unaccrued claims arising from such contracts involving, at the 
time with respect to which the reserve is computed, life, health, or 
accident contingencies. Accordingly, a company issuing variable annuity 
contracts shall qualify as a life insurance company for Federal income 
tax purposes if it satisfies the requirements of section 801(a) 
(relating to the definition of a life insurance company) and paragraph 
(b) of Sec. 1.801-3.
    (b) Special rules for variable annuities--(1) Adjusted reserves 
rate; assumed rate.

[[Page 507]]

The adjusted reserves rate for any taxable year with respect to the 
annuity contracts described in section 801(g)(1) and paragraph (a)(1) of 
this section, and the rate of interest assumed by the taxpayer for any 
taxable year in calculating the reserve on any such contract, shall be a 
rate equal to the current earnings rate determined under section 
801(g)(3) and subparagraph (2) of this paragraph. However, any change in 
the rate of interest assumed by the taxpayer in calculating the reserve 
on a variable annuity contract for any taxable year which is 
attributable to an increase or decrease in the current earnings rate, 
shall not be treated as a change of basis in computing reserves for 
purposes of section 806(b) (relating to certain changes in reserves) or 
section 810 (d)(1) (relating to adjustment for change in computing 
reserves).
    (2) Current earnings rate. (i) The current earnings rate for any 
taxable year with respect to the annuity contracts described in section 
801(g)(1) and paragraph (a)(1) of this section shall be the current 
earnings rate determined under section 805(b)(2) and paragraph (a)(2) of 
Sec. 1.805-5 with respect to such contracts, reduced by the percentage 
obtained by dividing (a) the amount of the actuarial margin charge on 
all such variable annuity contracts issued by the taxpayer, by (b) the 
mean of the reserves for such contracts.
    (ii) For purposes of section 801(g)(3) and subdivision (i) of this 
subparagraph, the term actuarial margin charge means any amount retained 
by the company from gross investment income pursuant to the terms of the 
variable annuity contract in excess of any portion of the investment 
expenses which is attributable to such contract and which is deductible 
under section 804(c) and paragraph (b) of Sec. 1.804-4.
    (3) Increases and decreases in reserves. (i) Section 801(g)(4) 
provides that for purposes of section 810 (a) and (b) (relating to 
adjustments for increases or decreases in certain reserves), the sum of 
the items described in section 810(c) and paragraph (b) of Sec. 1.810-2 
taken into account as of the close of the taxable year shall be 
adjusted:
    (a) By subtracting therefrom the sum of any amounts added from time 
to time (for the taxable year) to the reserves for variable annuity 
contracts described in section 801(g)(1) and paragraph (a)(1) of this 
section by reason of realized or unrealized appreciation in the value of 
the assets held in relation thereto, and
    (b) By adding thereto the sum of any amounts subtracted from time to 
time (for the taxable year) from such reserves by reason of realized or 
unrealized depreciation in the value of such assets.
    (ii) The application of section 801(g)(4) and subdivision (i) of 
this subparagraph may be illustrated by the following example:

    Example. Company M, a life insurance company issuing only variable 
annuity contracts of the type described in section 801(g)(1) and 
paragraph (a)(1) of this section, increased its life insurance reserves 
held with respect to such contracts during the taxable year 1959 by 
$275,000. Of the total increase in the reserves, $100,000 was 
attributable to premium receipts, $50,000 to dividends and interest, 
$100,000 to unrealized appreciation in the value of the assets held in 
relation to such reserves, and $25,000 to realized capital gains on the 
sale of such assets. As of the close of the taxable year 1959, the 
reserves held by company M with respect to all variable annuity 
contracts amounted to $1,275,000. However, under section 801(g)(4) and 
subdivision (i) of this subparagraph, this amount must be reduced by the 
$100,000 unrealized asset value appreciation and the $25,000 of realized 
capital gains. Accordingly, for purposes of section 810 (a) and (b), the 
amount of these reserves which is to be taken into account as of the 
close of the taxable year 1959 under section 810(c) is $1,150,000 
($1,275,000 less $125,000).

    (c) Companies issuing variable annuities and other contracts. (1) In 
the case of a life insurance company which issues both annuity contracts 
described in section 801(g)(1) and paragraph (a)(1) of this section and 
other contracts, the policy and other contract liability requirements 
(as defined in section 805(a) and paragraph (b) of Sec. 1.805-4) of such 
a company for any taxable year shall be considered to be the sum of:
    (i) The policy and other contract liability requirements computed 
with respect to the items which relate to such variable annuity 
contracts, and
    (ii) The policy and other contract liability requirements computed 
by excluding the items taken into account

[[Page 508]]

under subdivision (i) of this subparagraph.
    (2) [Reserved for regulations to be issued under section 
801(g)(5)(B).]
    (d) Termination. Paragraphs (1), (2), (3), (4), and (5) of section 
801(g) and paragraphs (a), (b), (c), and (d) of this section shall not 
apply with respect to any taxable year beginning after December 31, 
1962.

[T.D. 6610, 27 FR 8717, Aug. 31, 1962]



Sec. 1.801-8   Contracts with reserves based on segregated asset accounts.

    (a) Definitions--(1) Annuity contracts include variable annuity 
contracts. Section 801(g)(1)(A) provides that for purposes of part I, 
subchapter L, chapter 1 of the Code, an annuity contract includes a 
contract which provides for the payment of a variable annuity computed 
on the basis of recognized mortality tables and the investment 
experience of the company issuing such a contract. A variable annuity 
differs from the ordinary or fixed dollar annuity in that the annuity 
benefits payable under a variable annuity contract vary with the 
insurance company's investment experience with respect to such contracts 
while the annuity benefits paid under a fixed dollar annuity contract 
are guaranteed irrespective of the company's actual investment earnings.
    (2) Contracts with reserves based on a segregated asset account. (i) 
For purposes of part I, section 801(g)(1)(B) defines the term contract 
with reserves based on a segregated asset account as a contract 
(individual or group):
    (a) Which provides for the allocation of all or part of the amounts 
received under the contract to an account which, pursuant to State law 
or regulation, is segregated from the general asset accounts of the 
company,
    (b) Which provides for the payment of annuities, and
    (c) Under which the amounts paid in, or the amount paid as 
annuities, reflect the investment return and the market value of the 
segregated asset account.
    (ii) The term contract with reserves based on a segregated asset 
account includes a contract such as a variable annuity contract, which 
reflects the investment return and the market value of the segregated 
asset account, even though such contract provides for the payment of an 
annuity computed on the basis of recognized mortality tables, but the 
term includes such contract only for the period during which it 
satisfies the requirements of section 801(g)(1)(B) and subdivision (i) 
of this subparagraph. However, such term does not include a pension 
contract written on the basis of the so-called new-money concept. Thus, 
for example, such term does not include a pension contract whereby 
reserves are credited on the basis of the company's new high yield 
investments. Furthermore, such term does not include a contract which 
during the taxable year contains a right to participate in the divisible 
surplus of the company where such right merely reflects the company's 
investment return. Nevertheless, the term does include a contract which 
meets the requirements of section 801(g)(1)(B) and of this subparagraph 
even if part of the amounts received are, for example, allocated to 
reserves under provisions of the contract which are written on the basis 
of the new-money concept. However, such reserves do not qualify as a 
segregated asset account referred to in section 801(g) and this section.
    (iii) If at any time during the taxable year a contract otherwise 
satisfying the requirements of section 801(g)(1)(B) and subdivision (i) 
of this subparagraph ceases to reflect current investment return and 
current market value, such contract shall not be considered as meeting 
the requirements of section 801(g)(1)(B)(iii) and subdivision (i) (c) of 
this subparagraph after such cessation. Thus, a contract with reserves 
based on a segregated asset account includes a contract under which the 
reflection of investment return and market value terminates at the 
beginning of the annuity payments, but only for the period prior to such 
termination. For example, if the purchaser of a variable annuity 
contract which meets such requirements elects an option which provides 
for the payment of a fixed dollar annuity, then such contract shall be 
considered as satisfying such requirements only for the period prior to 
the time such contract ceases to reflect current investment return and 
current market value. Furthermore, a group

[[Page 509]]

annuity contract which satisfies the requirements of section 
801(g)(1)(B) and subdivision (i) of this subparagraph shall be 
considered as continuing to meet such requirements even though a 
certificate holder under the group contract elects an option which 
provides for the payment of a fixed dollar annuity. However, the annuity 
attributable to such certificate holder shall not be considered as 
satisfying such requirements as of the time such annuity ceases to 
reflect current investment return and current market value. On the other 
hand, a group annuity contract which does not reflect current market 
value shall not be considered as satisfying such requirements even 
though a certificate holder under the group contract elects an option 
which provides for the payment of a variable annuity. However, the 
variable annuity attributable to such certificate holder shall be 
considered as satisfying such requirements as of the time such variable 
annuity commences to reflect current investment return and current 
market value.
    (b) Life insurance reserves. Section 801(g)(2) provides that for 
purposes of section 801(b)(1)(A), the reflection of the investment 
return and the market value of the segregated asset account shall be 
considered an assumed rate of interest. Thus, the reserves held with 
respect to contracts described in section 801(g)(1) and paragraph (a) of 
this section shall qualify as life insurance reserves within the meaning 
of section 801(b)(1) and paragraph (a) of Sec. 1.801-4 provided such 
reserves are required by law (as defined in paragraph (b) of Sec. 1.801-
5) and are set aside to mature or liquidate, either by payment or 
reinsurance, future unaccrued claims arising from such contracts with 
reserves based on segregated asset accounts involving, at the time with 
respect to which the reserve is computed, life, health, or accident 
contingencies. Accordingly, a company issuing contracts with reserves 
based on segregated asset accounts shall qualify as a life insurance 
company for Federal income tax purposes if it satisfies the requirements 
of section 801(a) (relating to the definition of a life insurance 
company) and paragraph (b) of Sec. 1.801-3.
    (c) Separate accounting. (1) For purposes of part I, section 
801(g)(3) provides that a life insurance company (as defined in section 
801(a) and paragraph (b) of Sec. 1.801-3) which issues contracts with 
reserves based on segregated asset accounts (as defined in section 801 
(g)(1)(B) and paragraph (a)(2) of this section) shall separately account 
for each and every income, exclusion, deduction, asset, reserve, and 
other liability item which is properly attributable to such segregated 
asset accounts. In those cases where such items are not directly 
accounted for, separate accounting shall be made:
    (i) According to the method regularly employed by the company, if 
such method is reasonable, and
    (ii) In all other cases in a manner which, in the opinion of the 
district director, is reasonable.

A method of separate accounting for such items as are not accounted for 
directly will be deemed ``regularly employed'' by a life insurance 
company if the method was consistently followed in prior taxable years, 
or if, in the case of a company which has never before issued contracts 
with reserves based on segregated asset accounts, the company initiates 
in the first taxable year for which it issues such contracts a 
reasonable method of separate accounting for such items and consistently 
follows such method thereafter. Ordinarily, a company regularly employs 
a method of accounting in accordance with the statute of the State, 
Territory, or the District of Columbia, in which it operates.
    (2) Every life insurance company issuing contracts with reserves 
based on segregated asset accounts shall keep such permanent records and 
other data relating to such contracts as is necessary to enable the 
district director to determine the correctness of the application of the 
rules prescribed in section 301(g) and this section and to ascertain the 
accuracy of the computations involved.
    (d) Investment yield. (1) For purposes of part I, section 
801(g)(4)(A) provides that the policy and other contract liability 
requirements (as determined under section 805), and the life insurance 
company's share of investment yield (as determined under sections

[[Page 510]]

804(a) or 809(b)), shall be separately computed:
    (i) With respect to the items separately accounted for in accordance 
with section 801(g)(3) and paragraph (c) of this section, and
    (ii) Excluding the items taken into account under subdivision (i) of 
this subparagraph.

Thus, for purposes of determining both taxable investment income and 
gain or loss from operations, a life insurance company shall separately 
compute the life insurance company's share of the investment yield on 
the assets in its segregated asset account without regard to the policy 
and other contract liability requirements of, and the investment income 
attributable to, contracts with reserves that are not based on the 
segregated asset account. Such separate computations shall be made after 
any allocation required under section 801(g)(4)(B) and subparagraph (2) 
of this paragraph.
    (2)(i) Section 801(g)(4)(B) provides that if the net short-term 
capital gain (as defined in section 1222(5)) exceeds the net long-term 
capital loss (as defined in section 1222(8)), determined without regard 
to any separate computations under section 801(g)(4)(A) and subparagraph 
(1) of this paragraph, then such excess shall be allocated between 
section 801(g)(4)(A) (i) and (ii) and subparagraph (1) (i) and (ii) of 
this paragraph. Such allocation shall be in proportion to the respective 
contributions to such excess of the items taken into account under each 
such section and subparagraph. The allocation under this subparagraph 
shall be made before the separate computations prescribed by section 
801(g)(4)(A) and subparagraph (1) of this paragraph.
    (ii) The operation of the allocation required under section 
801(g)(4)(B) and subdivision (i) of this subparagraph may be illustrated 
by the following examples:

    Example 1. For the taxable year 1962, T, a life insurance company 
which issues regular life insurance and annuity contracts and contracts 
with reserves based on segregated asset accounts, had (without regard to 
section 801(g)(4)(A)) realized short-term capital gains of $10,000 and 
short-term capital losses of $10,000 attributable to its general asset 
accounts and realized short-term capital gains of $12,000 attributable 
to its segregated asset accounts. For the taxable year 1962, the excess 
of the net short-term capital gain ($10,000+$12,000-$10,000, or $12,000) 
over the net long-term capital loss (0) was $12,000. Of the excess of 
$12,000, 100 percent was contributed by the segregated asset accounts. 
Applying the provisions of section 801(g)(4)(B), T would allocate the 
entire $12,000 to its segregated asset accounts for such taxable year.
    Example 2. The facts are the same as in example 1 except that for 
the taxable year 1962, T had (without regard to section 801(g)(4)(A)) 
realized short-term capital losses of $8,000 attributable to its general 
asset accounts and realized long-term capital gains of $1,000 and long-
term capital losses of $5,000 attributable to its segregated asset 
accounts. For the taxable year 1962, the excess of the net short-term 
capital gain ($10,000+$12,000-$8,000, or $14,000) over the net long-term 
capital loss ($5,000-$1,000, or $4,000) was $10,000. Of the excess of 
$10,000, the general asset accounts contributed 20 percent ($2,000 
($10,000-$8,000)$10,000) and the segregated asset accounts 
contributed 80 percent ($8,000 ($12,000-$4,000)$10,000). 
Applying the provisions of section 801(g)(4)(B), T would allocate $2,000 
($10,000 x 20 percent) to its general asset accounts and $8,000 
($10,000 x 80 percent) to its segregated asset accounts for such taxable 
year.
    Example 3. W is a life insurance company which issues regular life 
insurance and annuity contracts and contracts with reserves based on 
either of two segregated asset accounts, Separate Account C or Separate 
Account D. For the taxable year 1962, W had (without regard to section 
801(g)(4)(A)) realized short-term capital gains of $16,000 and long-term 
capital losses of $15,000 attributable to its general asset accounts, 
long-term capital gains of $12,000 and short-term capital losses of 
$6,000 attributable to Separate Account C and long-term capital gains of 
$7,000 and short-term capital losses of $5,000 attributable to Separate 
Account D. For the taxable year 1962, the excess of the net short-term 
capital gain ($16,000-$6,000-$5,000) over the net long-term capital loss 
(0) was $5,000. Of the $5,000 excess, 20 percent 
($16,000-$15,000$5,000) was contributed by the general asset 
accounts, leaving 80 percent as the amount contributed by the segregated 
asset accounts. Applying the provisions of section 801(g)(4)(B) W would 
allocate $1,000 (20 percent of $5,000) to the general asset accounts, 
leaving $4,000 (80 percent of $5,000) to be allocated among the 
segregated asset accounts, Separate Account C and Separate Account D. W 
would allocate $3,000 of the $4,000 to Separate Account C computed as 
follows:

                           ($4,000) x ($12,000-$6,000)                  
$3,000=                                                                 
                    ($12,000-$6,000)+($7,000-$5,000)                    
                                                                        


[[Page 511]]

W would allocate $1,000 of the $4,000 to Separate Account D computed as 
follows:

                           ($4,000) x ($7,000-$5,000)                   
$1,000=                                                                 
                    ($12,000-$6,000)+($7,000-$5,000)                    
                                                                        

    (e) Policy and other contract liability requirements. (1) For 
purposes of part I, section 801(g)(5)(A) provides that with respect to 
life insurance reserves based on segregated asset accounts (as defined 
in section 801(g)(1)(B) and paragraph (a)(2) of this section), the 
adjusted reserves rate and the current earnings rate for purposes of 
section 805(b), and the rate of interest assumed by the taxpayer for 
purposes of sections 805(c) and 809(a)(2), shall be a rate equal to the 
current earnings rate determined under section 805(b)(2) and paragraph 
(a)(2) of Sec. 1.805-5 with respect to the items separately accounted 
for in accordance with section 801(g)(3), reduced by the percentage 
obtained by dividing:
    (i) Any amount retained with respect to all of the reserves based on 
a segregated asset account by the life insurance company from gross 
investment income (as defined in section 804(b) and paragraph (a) of 
Sec. 1.804-3) on segregated assets, to the extent such retained amount 
exceeds the deductions allowable under section 804(c) which are 
attributable to such reserves, by
    (ii) The means of such reserves.
    (2) For purposes of part I, section 801 (g)(5)(B) provides that with 
respect to reserves based on segregated asset accounts other than life 
insurance reserves, there shall be included as interest paid within the 
meaning of section 805(e)(1) and paragraph (b)(1) of Sec. 1.805-8, an 
amount equal to the product of the means of such reserves multiplied by 
the rate of interest assumed as defined in section 801(g)(5)(A) and 
subparagraph (1) of this paragraph.
    (3) For purposes of this paragraph, any change in the rate of 
interest assumed by the taxpayer in calculating the reserve on a 
contract with reserves based on a segregated asset account for any 
taxable year beginning after December 31, 1961, which is attributable to 
an increase or decrease in the current earnings rate, shall not be 
treated as a change of basis in computing reserves for purposes of 
section 806(b) (relating to certain changes in reserves) or section 810 
(d)(1) (relating to adjustment for change in computing reserves).
    (4) The provisions of section 801(g) (3) through (5) may be 
illustrated by the following example. For purposes of this example, it 
is assumed that all computations have been carried out to a sufficient 
number of decimal places to insure substantial accuracy and to eliminate 
any significant error in the resulting tax liability.

    Example. The books of R, a life insurance company, discloses the 
following facts with respect to items of investment yield, deductions, 
assets, and reserves for the taxable year 1962:
    (a) Excerpts from Company Financial Statements.

------------------------------------------------------------------------
                                       Company                          
        (1) Investment yield           regular     Separate    Separate 
                                       account     account A   account B
------------------------------------------------------------------------
Interest wholly tax-exempt.........     $100,000      $3,000      $1,000
Interest--other....................   10,000,000       8,000      15,000
Dividends received.................      200,000      25,000      27,000
Other items of investment yield....      100,000       2,000       1,000
                                    ------------------------------------
Gross investment income............   10,400,000      38,000      44,000
Less deductions (sec. 804(c))......    1,000,000       4,000       4,400
                                    ------------------------------------
Investment yield...................    9,400,000      34,000      39,600
                                    ------------------------------------
(2) Assets and reserves:                                                
  (i) Assets:                                                           
    Jan. 1, 1962...................  190,000,000  ..........  ..........
    Dec. 31, 1962..................  210,000,000   1,600,000   1,800,000
    Mean...........................  200,000,000     800,000     900,000
                                    ------------------------------------
  (ii) Life insurance reserves:                                         
    Jan. 1, 1962...................  152,000,000  ..........  ..........
    Dec. 31, 1962..................  168,000,000   1,600,000   1,640,000
    Mean...........................  160,000,000     800,000     820,000
                                    ------------------------------------
  (iii) Reserves based on                                               
   segregated asset accounts other                                      
   than life insurance reserves:                                        
    Jan. 1, 1962...................  ...........  ..........  ..........
    Dec. 31, 1962..................  ...........  ..........     120,000
    Mean...........................  ...........  ..........      60,000
------------------------------------------------------------------------

    (b) Additional facts. In addition to the facts assumed in (a) above, 
assume the following: The company retained with respect to reserves 
based upon segregated asset accounts a total of $4,720 from gross 
investment income on Separate Account A and $5,720 from gross investment 
income on Separate Account B. With respect to the Company Regular 
Account computed without regard to the

[[Page 512]]

items in either of the separate accounts, the policy and other contract 
liability requirement is $6,580,000 and the required interest is 
$5,640,000. There are no items of interest paid with respect to the 
separate accounts other than those computed under section 801(g)(5)(B). 
Based on these facts, the current earnings rate (sec. 805(b)); adjusted 
reserves rate (sec. 805 (b)); and rate of interest assumed (secs. 805(c) 
and 809(a)(2)); and the policy and other contract liability requirements 
are determined for each of the Separate Accounts A and B (and the policy 
and other contract liability requirements for the Company Regular 
Account) as set forth in items (c) through (1) below.
    (c) Separate Account A. The current earnings rate determined under 
section 805 (b)(2) with respect to the items separately accounted for 
under Separate Account A, prior to the reduction provided for under 
section 801(g)(5)(A), is 4.25 percent (the investment yield, $34,000, 
divided by the mean of the assets, $800,000). The company retained with 
respect to such reserves from gross investment income on Separate 
Account A a total of $4,720. The company had deductions allowable under 
section 804(c) with respect to such account of $4,000. Accordingly, for 
purposes of section 801(g)(5)(A)(i), the amount retained by the company 
was $720 (the total amount retained of $4,720 less the deductions 
allowable under section 804(c) of $4,000). The reduction percentage for 
purposes of section 801(g)(5)(A) is 0.09 percent (the amount retained of 
$720 divided by the mean of the life insurance reserves of $800,000). 
Therefore, the adjusted reserves rate and the current earnings rate for 
purposes of section 805(b), and the rate of interest assumed for 
purposes of sections 805(c) and 809(a)(2) is equal to 4.16 percent (the 
current earnings rate of 4.25 percent less the reduction percentage of 
0.09 percent).
    The policy and other contract liability requirements with respect to 
Separate Account A is determined as follows: For purposes of section 
805(a) (1) and (2), the amount is $33,280 (the mean of the life 
insurance reserves, $800,000, multiplied by the current earnings rate, 
as determined under section 801(g)(5)(A), 4.16 percent). Thus, the 
policy and other contract liability requirement for Separate Account A 
is $33,280.
    (d) Separate Account B. The current earnings rate determined under 
section 805 (b)(2) with respect to the items separately accounted for 
under Separate Account B, prior to the reduction provided for under 
section 801(g)(5)(A), is 4.40 percent (the investment yield, $39,600 
divided by the mean of the assets, $900,000). The company retained with 
respect to such reserves from gross investment income on Separate 
Account B a total of $5,720. The company had deductions allowable under 
section 804(c) with respect to such account of $4,400. Accordingly, for 
purposes of section 801(g)(5)(A)(i) the amount retained by the company 
was $1,320 (the total amount retained of $5,720 less the deductions 
allowable under section 804(c) of $4,400). The reduction percentage for 
purposes of section 801(g)(5)(A) is 0.15 percent (the amount retained of 
$1,320 divided by the mean of the reserves based on Separate Account B 
of $880,000 ($820,000 plus $60,000)). Therefore, the adjusted reserves 
rate and the current earnings rate for purposes of section 805(b), and 
the rate of interest assumed for purposes of section 805(c) and 
809(a)(2) is equal to 4.25 percent (the current earnings rate of 4.40 
percent less the reduction percentage of 0.15 percent).
    With respect to reserves based on segregated asset accounts other 
than life insurance reserves, Separate Account B had such reserves at 
December 31, 1962, of $120,000. The mean of such reserves was $60,000. 
The rate of interest assumed with respect to such reserves is 4.25 
percent, as computed above. Accordingly, there shall be included as 
interest paid within the meaning of section 805(e)(1) the amount of 
$2,550 (the mean of such reserves, $60,000 multiplied by the rate of 
interest assumed of 4.25 percent).
    The policy and other contract liability requirements with respect to 
Separate Account B is determined as follows:
    (1) For purposes of section 805(a)(1) and (2), the amount is $34,850 
(the mean of the life insurance reserves, $820,000, multiplied by the 
current earnings rate, as determined under section 801(g)(5)(A), 4.25 
percent).
    (2) For purposes of section 805(a)(3), the amount is $2,550 (the 
mean of the reserves based on Separate Account B other than life 
insurance reserves, $60,000, multiplied by the rate of interest assumed, 
as determined under section 801(g)(5)(A), 4.25 percent). It has been 
assumed that there was no other interest paid on Separate Account B 
within the meaning of section 805(e). If there was other interest paid 
with respect to Separate Account B that met the requirements of section 
805(e), however, then such interest would be included under section 
805(a)(3). Thus, the policy and other contract liability requirement for 
Separate Account B is $37,400 ($34,850+$2,550).
    (e) Company Regular Account. The policy and other contract liability 
requirements with respect to the Company Regular Account is $6,580,000 
(this amount is determined by the company in the manner provided by 
section 805 (and the regulations thereunder) without regard to either 
Separate Account A or Separate Account B).
    (f) Policyholders' share and company's share of investment yield--
section 804. The policyholders' and company's share of investment yield 
and taxable investment income are computed as follows:

[[Page 513]]



                       (1) Company Regular Account                      
                                                                        
Policyholders' share of investment       70%                            
 yield.                                   ($6,580,000$9,400,000)
                                          .                             
                                                                        
Company's share of investment yield      30%.                           
 (100% less 70%).                                                       
                                                                        
                         (2) Separate Account A                         
                                                                        
Policyholders' share of investment       97.8824% ($33,280              
 yield.                                   $34,000).             
                                                                        
Company's share of investment yield      2.1176%.                       
 (100% less 97.8824%).                                                  
                                                                        
                         (3) Separate Account B                         
                                                                        
Policyholders' share of investment       94.444% ($37,400               
 yield.                                   $39,600).             
                                                                        
Company's share of investment yield      5.556%.                        
 (100% less 94.444%).                                                   
                                                                        

    (g) The company's share of investment yield under section 804 is 
determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                    Company regular      Separate account A   Separate account B
                                                  account (30 percent     (2.1176 percent       (5.556 percent  
      Investment yield (from item (a)(1))         times each amount in   times each amount    times each amount 
                                                      item (a)(1))        in item (a)(1))      in item (a)(1))  
----------------------------------------------------------------------------------------------------------------
Interest wholly tax-exempt.....................          $30,000                   $63.53               $55.56  
Interest--other................................        3,000,000                   169.41               833.40  
Dividends received.............................           60,000                   529.40             1,500.12  
Other items of gross investment income.........           30,000                    42.35                55.56  
                                                ----------------------------------------------------------------
                                                       3,120,000                   804.69             2,444.64  
    Less deductions............................          300,000                    84.70               244.46  
                                                ----------------------------------------------------------------
Investment yield...............................        2,820,000                   719.99             2,200.18  
----------------------------------------------------------------------------------------------------------------

    (h) Taxable investment income. The company's taxable investment 
income (without regard to any excess of net long-term capital gain over 
net short-term capital loss) is determined as follows:

                                                                        
                                                                        
                                                                        
Life insurance                                                          
 company's                                                              
 share of                                                               
 investment                                                             
 yield                                                                  
 ($2,820,000+$7                                                         
 19.99+                                                                 
 $2,200.18)....    ..................................  $2,              
                                                       822              
                                                       ,92              
                                                       0.1              
                                                         7              
Less:                                                                   
  Company's                                                             
   share of                                                             
   interest                                                             
   wholly tax-                                                          
   exempt                                                               
   ($30,000+                                                            
   $63.53+$55.5                                                         
   6)=$30,119.0                                                         
   9                                                                    
  85 percent of                                                         
   company's                                                            
   share of                                                             
   dividends                                                            
   received                                                             
   (but not to                                                          
   exceed 85%                                                           
   of taxable                                                           
   investment                                                           
   income                                                               
   computed                                                             
   without                                                              
   regard to                                                            
   this                                                                 
   deduction)                                                           
   (85% x $62,0                                                         
   29.52)                                                               
   ($60,000+                                                            
   $529.40+$1,5                                                         
   00.12)=$52,7                                                         
   25.09                                                                
  Small                                                                 
   business                                                             
   deduction                                                            
   (10% of                                                              
   investment                                                           
   yield,                                                               
   $9,473,600,                                                          
   not to                                                               
   exceed                                                               
   $25,000)                                                             
   =$25,000.00.    ..................................  107              
                                                       ,84              
                                                       4.1              
                                                         8              
                                                      ------            
    Taxable                                                             
     investment                                                         
     income....    ..................................  2,7              
                                                       15,              
                                                       075              
                                                       .99              
------------------------------------------------------------------------

    (i) Required interest--section 809(a)(2)-- (1) Separate Account A. 
The rate of interest assumed by the company, with respect to Separate 
Account A is 4.16 percent (see (c) above). The required interest for 
purposes of section 809(a)(2) is determined as follows:

Life insurance reserves: 4.16% (rate assumed) times                     
 $800,000 (mean of life insurance reserves).............      $33,280.00
                                                                        

    (2) Separate Account B. The rate of interest assumed by the company 
with respect to Separate Account B is 4.25 percent (see (d) above). The 
required interest for purposes of section 809(a)(2) is determined as 
follows:

(i) Life insurance reserves: 4.25% (rate assumed) times                 
 $820,000 (mean of life insurance reserves).............      $34,850.00
(ii) Other section 810(c) reserves: 4.25% (rate assumed)                
 times $60,000 (mean of reserves other than life                        
 insurance reserves)....................................       $2,550.00
                                                         ---------------
                                                              $37,400.00
                                                                        

    (3) Company Regular Account. The required interest with respect to 
the Company Regular Account is $5,640,000 (this amount is assumed for 
purposes of this example, but it would be determined by the company in 
the manner provided by section 809 without regard to either Separate 
Account A or Separate Account B).
    (j) Policyholders' share and company's share of investment yield--
section 809. The policyholders' share and the company's share of 
investment yield for purposes of section 809 is determined as follows:

[[Page 514]]



                                                                                                                
                                                                                                                
                                                                                                                
(1) Company                                                                                                     
 Regular                                                                                                        
 Account:                                                                                                       
    Policyholde  60% ($5,640,000$9,400,000).                                                            
     rs' share                                                                                                  
     of                                                                                                         
     investment                                                                                                 
     yield.                                                                                                     
    Company's    40%.                                                                                           
     share of                                                                                                   
     investment                                                                                                 
     yield (100                                                                                                 
     percent--6                                                                                                 
     0%)..                                                                                                      
(2) Separate                                                                                                    
 Account A:                                                                                                     
    Policyholde  97.8824% ($33,280$34,000).                                                             
     rs' share                                                                                                  
     of                                                                                                         
     investment                                                                                                 
     yield.                                                                                                     
    Company's    2.1176%.                                                                                       
     share of                                                                                                   
     investment                                                                                                 
     yield                                                                                                      
     (100%--97.                                                                                                 
     8824                                                                                                       
     percent)..                                                                                                 
(3) Separate                                                                                                    
 Account B:                                                                                                     
    Policyholde  94.444% ($37,400$39,600).                                                              
     rs' share                                                                                                  
     of                                                                                                         
     investment                                                                                                 
     yield.                                                                                                     
    Company's    5.556%.                                                                                        
     share of                                                                                                   
     investment                                                                                                 
     yield                                                                                                      
     (100%--94.                                                                                                 
     444%)..                                                                                                    
----------------------------------------------------------------------------------------------------------------

    (k) The company's share of investment yield under section 809 is 
determined as follows:

----------------------------------------------------------------------------------------------------------------
                                                                Separate account A                              
  Investment yield (from item     Company regular account     (2.1176 percent times    Separate account B (5.556
            (a)(1))                (40 percent times each      each amount in item     percent times each amount
                                   amount in item (a)(1))            (a)(1))                in item (a)(1))     
----------------------------------------------------------------------------------------------------------------
Interest wholly tax-exempt.....                    $40,000                     $63.53                     $55.56
Interest--other................                  4,000,000                     169.41                     833.40
Dividends received.............                     80,000                     529.40                   1,500.12
Other items of gross investment                                                                                 
 income........................                     40,000                      42.35                      55.56
                                --------------------------------------------------------------------------------
                                                 4,160,000                     804.69                   2,444.64
    Less deductions............                    400,000                      84.70                     244.46
                                --------------------------------------------------------------------------------
Investment yield...............                  3,760,000                     719.99                   2,200.18
----------------------------------------------------------------------------------------------------------------

    (1) Deductions under section 809(d)(8). For purposes of section 
809(d)(8), the life insurance company's share of each of such items is 
determined as follows:

(1) Wholly tax-exempt interest ($40,000+$63.53+$55.56)....    $40,119.09
(2) Dividends received 85% x  $82,029.52                                
 ($80,000+$529.40+$1,500.12) (it is assumed for purposes                
 of this example that this amount does not exceed 85% of                
 the gain from operations as computed under sec.                        
 809(d)(8)(B))............................................     69,725.09
                                                                        

    (f) Increases and decreases in reserves. (1) Section 801(g)(6) 
provides that for purposes of section 810 (a) and (b) (relating to 
adjustments for increases or decreases in certain reserves), the sum of 
the items described in section 810(c) and paragraph (b) of Sec. 1.810-2 
taken into account as of the close of the taxable year shall be 
adjusted:
    (i) By subtracting therefrom the sum of any amounts added from time 
to time (for the taxable year) to the reserves separately accounted for 
in accordance with section 801(g)(3) and paragraph (c) of this section 
by reason of realized or unrealized appreciation in value of the assets 
held in relation thereto, and
    (ii) By adding thereto the sum of any amounts subtracted from time 
to time (for the taxable year) from such reserves by reason of realized 
or unrealized depreciation in the value of such assets.
    (2) The provisions of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. Company M, a life insurance company issuing only contracts 
with reserves based on segregated asset accounts as defined in section 
801(g)(1)(B) and paragraph (a)(2) of this section (other than contracts 
described in section 805(d)(1) (A), (B), (C), or (D)), increased its 
life insurance reserves held with respect to such contracts during the 
taxable year 1962 by $275,000. Of the total increase in the reserves, 
$100,000 was attributable to premium receipts, $50,000 to dividends and 
interest, $100,000 to unrealized appreciation in the value of the assets 
held in relation to such reserves, and $25,000 to realized capital gains 
on the sale of such assets. As of the close of the taxable year 1962, 
the reserves held by company M with respect to all such contracts 
amounted to $1,275,000. However, under section 801(g)(6) and this 
subparagraph, this amount must be reduced by the $100,000 unrealized 
asset value appreciation and the $25,000 of realized capital gains. 
Accordingly, for purposes of section 810(a) and (b), the amount of these 
reserves which is to be taken into account as of the close of the 
taxable year 1962 under section 810(c) is $1,150,000 ($1,275,000 less 
$125,000). However, for purposes of section 810 (a) and (b), the amount 
of these reserves which is to be taken into account as of the beginning 
of the taxable year 1963 under section 810(c) is

[[Page 515]]

$1,275,000 (the amount as of the close of the taxable year 1962 before 
reduction of $125,000 for unrealized appreciation and realized capital 
gains).

    (3)(i) Under section 801(g)(6), the deduction allowable for items 
described in section 809(d) (1) and (7) (relating to death benefits and 
assumption reinsurance, respectively) with respect to segregated asset 
accounts shall be reduced to the extent that the amount of such items is 
increased for the taxable year by appreciation (or shall be increased to 
the extent that the amount of such items is decreased for the taxable 
year by depreciation) not reflected in adjustments required to be made 
under subparagraph (1) of this paragraph.
    (ii) The provisions of this subparagraph may be illustrated by the 
following example:

    Example. On June 30, 1962, X, a life insurance company, reinsured a 
portion of its insurance contracts with reserves based on segregated 
asset accounts with Y, a life insurance company, under an agreement 
whereby Y agreed to assume and become solely liable under the contracts 
reinsured. The reserves on the contracts reinsured by X were $90,000, of 
which $10,000 was attributable to unrealized appreciation in the value 
of the assets held in relation to such reserves. However, no amounts had 
been added to the reserves by reason of the unrealized appreciation of 
$10,000 and consequently, the $10,000 was not reflected in adjustments 
to reserves under section 809(g)(6) or subparagraph (1) of this 
paragraph. Under the reinsurance agreement, X made a payment of $90,000 
in cash to Y for assuming such contracts. Applying the provisions of 
section 809(d)(7), and assuming no other such reinsurance transactions 
by X during the taxable year, X would have an allowable deduction of 
$90,000 as a result of this payment on June 30, 1962. However, applying 
the provisions of section 801(g)(6) and this subparagraph, the actual 
deduction allowed would be $80,000 ($90,000 less $10,000). See section 
806 (a) and Sec. 1.806-3 for the adjustments in reserves and assets to 
be made by X and Y as a result of this transaction. For the treatment by 
Y of this $90,000 payment, see section 809(c)(1) and paragraph (a)(1)(i) 
of Sec. 1.809-4.

    (g) Basis of assets held for certain pension plan contracts. Section 
801(g)(7) provides that in the case of contracts described in section 
805(d)(1) (A), (B), (C), (D), or (E) (relating to the definition of 
pension plan reserves), the basis of each asset in a segregated asset 
account shall (in addition to all other adjustments to basis) be (i) 
increased by the amount of any appreciation in value, and (ii) decreased 
by the amount of any depreciation in value; but only to the extent that 
such appreciation and depreciation are reflected in the increases and 
decreases in reserves, or other items described in section 801(g)(6), 
with respect to such contracts. Thus, there shall be no capital gains 
tax payable by a life insurance company on appreciation realized on 
assets in a segregated asset account to the extent such appreciation has 
been reflected in reserves, or other items described in section 
801(g)(6), for contracts described in section 805(d)(1) (A), (B), (C), 
(D), or (E) based on segregated asset accounts.
    (h) Additional separate computation--(1) Assets and total insurance 
liabilities. A life insurance company which issues contracts with 
reserves based on segregated asset accounts (as defined in section 
801(g)(1)(B) and paragraph (a)(2) of this section) shall separately 
compute and report with its return the assets and total insurance 
liabilities which are properly attributable to all of such segregated 
asset accounts. Each foreign corporation carrying on a life insurance 
business which issues such contracts shall separately compute and report 
with its return assets held in the United States and total insurance 
liabilities on United States business which are properly attributable to 
all of such segregated asset accounts.
    (2) Foreign life insurance companies. For adjustment under section 
819 in the case of a foreign life insurance company which issues 
contracts based on segregated asset accounts under section 801(g), see 
Sec. 1.819-2(b)(4).

[T.D. 6886, 31 FR 8681, June 23, 1966, as amended by T.D. 6970, 33 FR 
12044, Aug. 24, 1968; T.D. 7501, 42 FR 42341, Aug. 23, 1977]



Sec. 1.802(b)-1   Tax on life insurance companies.

    (a) For taxable years beginning after December 31, 1953, but before 
January 1, 1955, and ending after August 16, 1954, section 802(b) 
imposes a tax on the 1954 life insurance company taxable income of all 
life insurance companies (including a foreign life insurance company 
carrying on a life insurance business

[[Page 516]]

within the United States if with respect to its United States business 
it would qualify as a life insurance company under section 801). The tax 
so imposed is equal to 3 3/4 percent of the amount of such income not in 
excess of $200,000, plus 6 1/2 percent of the amount of such income in 
excess of $200,000. For the definition of the term ``1954 life insurance 
company taxable income'', see Sec. 1.805-1.
    (b) The taxable income of life insurance companies differs from the 
taxable income of other corporations. See section 803. Life insurance 
companies are entitled, in computing life insurance company taxable 
income, to the special deductions provided in part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code. The 
gross income, the deduction under section 803 (g)(1) for wholly tax-
exempt interest, and the deduction under section 242 for partially tax-
exempt interest, are decreased by the appropriate amortization of 
premium and increased by the appropriate accrual of discount 
attributable to the taxable year on bonds, notes, debentures, or other 
evidences of indebtedness held by a life insurance company. See section 
803 (i) and Sec. 1.803-6. Such companies are not subject to the 
provisions of subchapter P (section 1201 and following), chapter 1 of 
the Code, relating to capital gains and losses, nor to the provisions of 
section 171 (amortizable bond premium).
    (c) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provision of sections 801 to 807, 
inclusive, are applicable to the assessment and collection of the tax 
imposed by section 802, and life insurance companies are subject to the 
same penalties as are provided in the case of returns and payment of 
income tax by other corporations. The return shall be on Form 1120L.
    (d) Foreign life insurance companies not carrying on an insurance 
business within the United States are not taxable under section 802, but 
are taxable as other foreign corporations. See section 881.



Sec. 1.802-2   Taxable years affected.

    Section 1.802(b)-1 is applicable only to taxable years beginning 
after December 31, 1953, and before January 1, 1955, and all references 
to sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.802-3 
through 1.802-5 (other than paragraph (f)(2) of Sec. 1.802-3), except as 
otherwise provided therein, are applicable only to taxable years 
beginning after December 31, 1957, and all references to sections of 
part I, subchapter L, chapter 1 of the Code are to the Internal Revenue 
Code of 1954, as amended by the Life Insurance Company Income Tax Act of 
1959 (73 Stat. 112) and section 235(c)(1) of the Revenue Act of 1964 (78 
Stat. 126). Paragraph (f)(2) of Sec. 1.802-3 is applicable only to 
taxable years beginning after December 31, 1961, and all reference to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, as amended by the Life Insurance Company 
Income Tax Act of 1959 (73 Stat. 112), section 3 of the Act of October 
23, 1962 (76 Stat. 1134) and section 235(c)(1) of the Revenue Act of 
1964 (78 Stat. 126).

[T.D. 6886, 31 FR 8685, June 23, 1966]



Sec. 1.802-3   Tax imposed on life insurance companies.

    (a) In general. For taxable years beginning after December 31, 1957, 
section 802(a)(1) imposes a tax on the life insurance company taxable 
income (as defined in section 802(b) and paragraph (a) of Sec. 1.802-4) 
of every life insurance company (including a foreign life insurance 
company carrying on a life insurance business within the United States 
if with respect to its United States business it would qualify as a life 
insurance company under section 801(a)). The tax imposed by section 
802(a)(1) is payable upon the basis of returns rendered by the life 
insurance companies liable thereto. See subchapter A, chapter 61 
(section 6001 and following) of the Code.
    (b) Tax imposed. The tax imposed by section 802(a)(1) consists of a 
normal tax and a surtax computed as provided in section 11 as though the 
life insurance company taxable income (as defined in section 802(b)) 
were the taxable income referred to in section 11.

[[Page 517]]

    (c) Normal tax. The normal tax is computed by applying to the life 
insurance company taxable income the regular corporate normal tax rate 
(as in effect for the taxable year) provided by section 11(b).
    (d) Surtax. The surtax is computed by applying the regular corporate 
surtax rate (as in effect for the taxable year) provided by section 
11(c) to the amount by which the life insurance company taxable income 
exceeds the surtax exemption for the taxable year as determined under 
section 11(d). See sections 269 and 1551 and the regulations thereunder, 
for certain circumstances in which the surtax exemption may be 
disallowed in whole or in part.
    (e) Special rule for 1959 and 1960. See section 802(a)(3) and 
paragraph (a) of Sec. 1.802-5 for a transitional rule applicable in 
certain cases in determining tax liability for the taxable years 1959 
and 1960 by reason of the operation of section 802(b)(3).
    (f) Tax imposed in case of certain capital gains--(1) Taxable years 
beginning after December 31, 1958, and before January 1, 1962. For 
taxable years beginning after December 31, 1958, and before January 1, 
1962, if the net long-term capital gain (as defined in section 1222(7)) 
of any life insurance company exceeds its net short-term capital loss 
(as defined in section 1222(6)), section 802(a)(2) imposes a separate 
tax equal to 25 percent of such excess. This separate 25 percent tax 
rate applies whether or not there is life insurance company taxable 
income, taxable investment income, or a gain or loss from operations for 
the taxable year. For taxable years beginning after December 31, 1958, 
and before January 1, 1962, only the excess (if any) of net short-term 
capital gain (as defined in section 1222(5)) over net long-term capital 
loss (as defined in section 1222(8)) shall be taken into account in 
computing taxable investment income and gain or loss from operations. 
See sections 804(b) and 809(b). Except as modified by section 817 (rules 
relating to certain gains and losses), the general rules of the Code 
relating to gains and losses (such as the rules for determining the 
amount, characterization, and treatment thereof) shall apply with 
respect to life insurance companies.
    (2) Alternative tax in case of capital gains for taxable years 
beginning after December 31, 1961. For taxable years beginning after 
December 31, 1961, if the net long-term capital gain (as defined in 
section 1222(7)) of any life insurance company exceeds its net short-
term capital loss (as defined in section 1222(6)), section 802(a)(2) 
imposes an alternative tax in lieu of the tax imposed by section 
802(a)(1), if and only if such alternative tax is less than the tax 
imposed by section 802(a)(1). The alternative tax is the sum of:
    (i) A partial tax, computed as provided by section 802(a)(1), on the 
life insurance company taxable income determined by reducing the taxable 
investment income, and the gain from operations, by the amount of the 
excess of its net long-term capital gain over its net short-term capital 
loss, and
    (ii)(a) In the case of a taxable year beginning before January 1, 
1970, an amount equal to 25 percent of such excess, or
    (b) In the case of a taxable year beginning after December 31, 1969, 
an amount determined as provided in section 1201(a) and paragraph (a)(3) 
of Sec. 1.1201-1 on such excess.

In the computation of the partial tax, the deductions provided by 
sections 170 (as modified by section 809(a)(3)), 243, 244, 245 (as 
modified by sections 804 (a)(5) and 809(d)(8)(B)), and the limitation 
provided by section 809(f), shall not be recomputed as a result of the 
reduction of taxable investment income, and gain from operations, by the 
amount of such excess. Except as modified by section 817 (rules relating 
to certain gains and losses), the general rules of the Code relating to 
gains and losses (such as the rules for determining the amount, 
characterization and treatment thereof) shall apply with respect to life 
insurance companies.
    (g) Foreign life insurance companies. Foreign life insurance 
companies not carrying on an insurance business within the United States 
are not taxable under section 802, but are taxable as other foreign 
corporations. See section 881.
    (h) Assessment and collection of tax imposed. All provisions of the 
Internal Revenue Code and of the regulations in

[[Page 518]]

this part not inconsistent with the specific provisions of sections 801 
to 820, inclusive, are applicable to the assessment and collection of 
the tax imposed by section 802(a), and life insurance companies are 
subject to the same penalties as are provided in the case of returns and 
payment of income tax by other corporations. The return shall be on Form 
1120L.
    (i) Illustration of principles. The provisions of section 802(a), 
other than paragraph (3) thereof, and this section may be illustrated by 
the following example:

    Example. For the taxable year 1959, T, a life insurance company, has 
life insurance company taxable income of $300,000 (including $25,000 of 
net short-term capital gain) and $80,000 of net long-term capital gain. 
The tax of T under section 802(a) for 1959 is $170,500 ($90,000 normal 
tax, $60,500 surtax, and $20,000 capital gains tax) computed as follows:

                        Computation of Normal Tax                       
Life insurance company taxable income........................   $300,000
Normal tax (30% of $300,000).................................     90,000
                          Computation of Surtax                         
Life insurance company taxable income........................   $300,000
Less: Exemption from surtax..................................     25,000
                                                              ----------
    Excess of life insurance company taxable income subject             
     to surtax...............................................    275,000
Surtax (22% of $275,000).....................................     60,500
                    Computation of Capital Gains Tax                    
Excess of net long-term capital gain over net short-term                
 capital loss................................................    $80,000
Capital gains tax (25% of $80,000)...........................     20,000
                                                                        

    (j) Cross reference. In the case of a taxable year of a life 
insurance company ending after December 31, 1963, for which an election 
under section 1562(a)(1) by a controlled group of corporations is 
effective, the additional tax imposed by section 1562 may apply. See 
section 1562 and the regulations thereunder.

[T.D. 6513, 25 FR 12658, Dec. 10, 1960, as amended by T.D. 6845, 30 FR 
9740, Aug. 5, 1965; T.D. 6886, 31 FR 8685, June 23, 1966; T.D. 7337, 39 
FR 44972, Dec. 30, 1974]



Sec. 1.802-4   Life insurance company taxable income.

    (a) Life insurance company taxable income defined. Section 802(b) 
defines the term life insurance company taxable income, for purposes of 
part I, subchapter L, chapter 1 of the Code, as the sum of:
    (1) The taxable investment income (as defined in section 804), or, 
if smaller, the gain from operations (as defined in section 809),
    (2) If the gain from operations exceeds the taxable investment 
income, an amount equal to 50 percent of such excess, plus
    (3) The amount subtracted from the policyholders surplus account for 
the taxable year, as determined under section 815.

If for any taxable year there is a loss from operations (as defined in 
section 809(b)(2)), the amount taken into account under paragraphs (1) 
and (2) of section 802(b) and subparagraphs (1) and (2) of this 
paragraph shall be zero. However, even in such a case, there may still 
be an amount includible in life insurance company taxable income (and 
hence an amount subject to tax) by reason of an amount includible under 
section 802(b)(3) and subparagraph (3) of this paragraph.
    (b) Illustration of principles. The provisions of section 802(b) and 
this section may be illustrated by the following examples:

    Example 1. For the taxable year 1959, Y, a life insurance company, 
has taxable investment income of $250,000, and a gain from operations of 
$175,000. Y made no subtractions from the policyholders surplus account 
during such taxable year. For the taxable year 1959, Y has life 
insurance company taxable income of $175,000.
    Example 2. The facts are the same as in example 1 except that for 
the taxable year 1959, Y has a gain from operations of $400,000. For the 
taxable year 1959, Y has life insurance company taxable income of 
$325,000, computed by adding taxable investment income ($250,000) and 50 
percent ($75,000) of the amount ($150,000) by which the gain from 
operations ($400,000) exceeds the taxable investment income ($250,000).
    Example 3. For the taxable year 1959, W, a life insurance company, 
has taxable investment income of zero (0) and a gain from operations of 
$90,000. W made no subtractions from the policyholders surplus account 
during such taxable year. For the taxable year 1959, W has life 
insurance company taxable income of $45,000, computed by adding taxable 
investment income (0) and 50 percent ($45,000) of the amount ($90,000) 
by which the gain from operations ($90,000) exceeds the taxable 
investment income (0).
    Example 4. For the taxable year 1961, Z, a life insurance company, 
has taxable investment income of $100,000, a policyholders surplus 
account of $50,000 as of the beginning of such taxable year, a loss from 
operations (as defined in section 809(b)(2)) of $25,000, and

[[Page 519]]

subtractions from the policyholders surplus account in the amount of 
$20,000. For the taxable year 1961, Z has life insurance company taxable 
income of $20,000, as only the amount ($20,000) subtracted from the 
policyholders surplus account is taken into account.

[T.D. 6513, 25 FR 12658, Dec. 10, 1960]



Sec. 1.802-5   Special rule for 1959 and 1960.

    (a) Transitional rule. Section 802(a)(3) provides a transitional 
rule for the determination of the tax liability of a life insurance 
company for the taxable years 1959 and 1960 by reason of the operation 
of section 802(b)(3). Except as limited by section 802(a)(3) and 
paragraph (b) of this section, any increase in a life insurance 
company's tax that is attributable to the operation of section 802(b)(3) 
is taken into account only to the extent of one-third and two-thirds for 
the taxable years 1959 and 1960, respectively. To the extent there is an 
increase in a life insurance company's tax that is attributable to the 
operation of section 802(b)(3) which is not taken into account for the 
taxable years 1959 and 1960 because of the transitional rule provided by 
section 802(a)(3) and this paragraph, such amounts shall be included in 
``other accounts'' under section 815(a)(3). For taxable years commencing 
after December 31, 1960, the full amount of any increase in tax due to 
the operation of section 802(b)(3) shall be imposed without any further 
transitional reduction.
    (b) Limitations. The transitional rule provided by section 802(a)(3) 
is limited solely to an increase in tax under section 802(b)(3) that is 
occasioned by the operation of section 815(c)(3) (relating to 
subtractions from the policyholders surplus account by reason of 
distributions to shareholders). This rule is further limited to actual 
distributions that are made by life insurance companies in 1959 or 1960 
and does not extend to other distributions that are treated under 
section 815(d)(2)(B) as made by life insurance companies in 1959 or 
1960. Furthermore, section 802(a)(3) shall not apply to any increase in 
tax under section 802(b)(3) that is attributable to other subtractions 
from the policyholders surplus account by reason of the operation of the 
special rules contained in section 815(d). However, the transitional 
rule provided by section 802(a)(3) does apply in the case of a 
distribution to which section 815(e)(1)(B) (ii) applies.
    (c) Illustration of principles. The provisions of section 802(a)(3) 
and this section may be illustrated by the following example:

    Example. For the taxable year 1960, X, a life insurance company, had 
taxable investment income of $9,000, gain from operations of $27,000, 
and subtractions from the policyholders surplus account of $22,000. 
Based upon these figures, X had life insurance company taxable income of 
$40,000 for 1960, of which $18,000 was includible under section 802(b) 
(1) and (2) and $22,000 under section 802(b)(3). Applying the tax 
imposed by section 802(a)(1) (at rates as in effect for 1960), without 
regard to the transitional rule of section 802(a)(3), X would have a tax 
liability of $15,300 ($40,000 multiplied by 52 percent, less $5,500). 
However, applying the transitional rule of section 802(a)(3), the actual 
tax liability of X, for 1960, would be $12,000, computed as follows:

(1) Total tax liability (without regard to sec. 802(a)(3))...    $15,300
(2) Life insurance company taxable income.........    $40,000           
(3) Amount subtracted from policyholders surplus                        
 account..........................................     22,000           
(4) Item (2) less item (3)........................     18,000           
(5) Tax on amount includible under sec. 802(b) (1) and (2)              
 (30% of $18,000)............................................      5,400
                                                   ------------         
(6) Tax attributable to sec. 802(b)(3) (item (1) less item              
 (5))........................................................      9,900
(7) Less: 33 1/3 percent of tax attributable to sec.                    
 802(b)(3) (1/3 of $9,900)...................................      3,300
(8) Tax liability for 1960 after application of sec.                    
 802(a)(3) (item (1) less item (7))..........................     12,000
                                                                        

[T.D. 6513, 25 FR 12659, Dec. 10, 1960]



Sec. 1.803-1   Life insurance reserves.

    (a) The term ``life insurance reserves'' is defined in section 
803(b). Generally, such reserves, as in the case of level premium life 
insurance, are held to supplement the future premium receipts when the 
latter, alone, are insufficient to cover the increased risk in the later 
years. In the case of cancellable health and accident policies and 
similar cancellable contracts, the unearned premiums held to cover the 
risk for the unexpired period covered by the premiums are not included 
in life insurance reserves. Unpaid loss reserves for noncancellable 
health and accident policies are included in life insurance reserves if 
they are computed or estimated on the basis of recognized

[[Page 520]]

mortality or morbidity tables and assumed rates of interest.
    (b) In the case of an assessment life insurance company or 
association, life insurance reserves include sums actually deposited by 
such company or association with State or Territorial officers pursuant 
to law as guaranty or reserve funds, and any funds maintained under the 
charter or articles of incorporation or association of such company or 
association, or bylaws (approved by the State insurance commissioner) of 
such company or association, exclusively for the payment of claims 
arising under certificates of membership or policies issued upon the 
assessment plan and not subject to any other use.
    (c) Life insurance reserves, except as otherwise provided in section 
803(b), must be required by law either by express statutory provisions 
or by rules and regulations of the insurance department of a State, 
Territory, or the District of Columbia when promulgated in the exercise 
of a power conferred by statute but such requirement, without more, is 
not conclusive; for example, life insurance reserves do not include 
reserves required to be maintained to provide for the ordinary running 
expenses of a business which must be currently paid by every company 
from its income if its business is to continue, such as taxes, salaries, 
and unpaid brokerage; nor do they include the net value of risks 
reinsured in other solvent companies; liability for premiums paid in 
advance; liability for annual and deferred dividends declared or 
apportioned; liability for dividends left on deposit at interest; 
liability for accrued but unsettled policy claims whether known or 
unreported; liability for supplementary contracts not involving, at the 
time with respect to which the liability is computed, life, health, or 
accident contingencies.
    (d) In any case where reserves are claimed, sufficient information 
must be filed with the return to enable the district director to 
determine the validity of the claim. Only reserves which are required by 
law or insurance department ruling, which are peculiar to insurance 
companies, and which are dependent upon interest earnings for their 
maintenance will, except as otherwise specifically provided in section 
803(b), be considered as life insurance reserves. A company is permitted 
to make use of the highest aggregate reserve required by any State or 
Territory or the District of Columbia in which it transacts business, 
but the reserve must have been actually held.
    (e) In the case of life insurance companies issuing policies 
covering life, health, and accident insurance combined in one policy 
issued on the weekly premium payment plan, continuing for life and not 
subject to cancellation, it is required that reserve funds thereon be 
based upon recognized mortality or morbidity tables covering disability 
benefits of the kind contained in policies issued by this particular 
class of companies but they need not be required by law.



Sec. 1.803-2   Adjusted reserves.

    For the purpose of determining ``required interest'' for taxable 
years beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, certain reserves computed on a preliminary 
term method are to be adjusted by increasing such reserves by 7 percent. 
The reserves to be thus adjusted are reserves computed on preliminary 
term methods, such as the Illinois Standard, or the Select and Ultimate 
methods. Only reserves on policies in the modification period are to be 
so adjusted. Where reserves under a preliminary term method are the same 
as on the level premium method, and in the case of reserves for extended 
or paid-up insurance, no adjustment is to be made. The reserves are thus 
adjusted, and the rate of interest on which they are computed, should be 
reported in Schedule A, Form 1120L.



Sec. 1.803-3   Interest paid or accrued.

    Interest paid or accrued is one of the elements to be used in 
computing the amount of ``required interest'' for purposes of 
determining the reserve interest credit provided in section 805. See 
Sec. 1.805-1. Interest paid or accrued consists of (a) interest paid or 
accrued on indebtedness (except indebtedness incurred or continued to 
purchase or carry tax-exempt securities as set forth in section 
803(f)(1)) and (b) amounts in the nature of interest paid or accrued

[[Page 521]]

on certain contracts, as provided in section 803(f)(2). Interest on 
indebtedness includes interest on dividends held on deposit and 
surrendered during the taxable year but does not include interest paid 
or accrued on deferred dividends. Life insurance reserves as defined in 
Sec. 1.803-1 are not indebtedness. Dividends left with the company to 
accumulate at interest are a debt and not a reserve liability. Amounts 
in the nature of interest include so-called excess-interest dividends as 
well as guaranteed interest paid or accrued within the taxable year on 
insurance or annuity contracts (or contracts arising out of insurance or 
annuity contracts) which, at the time of payment, do not involve life, 
health, or accident contingencies. It is immaterial whether the optional 
mode of settlement specified in the insurance or annuity contract arises 
from an option exercised by the insured during his or her lifetime or 
from an option exercised by a beneficiary after the policy has matured, 
frequently referred to as a supplementary contract not involving life 
contingencies; for example, a contract to pay the insurance benefit in 
10 annual installments. No distinction is made based on the person 
choosing the method of payment, and the full amount of the interest paid 
or accrued and not merely the guaranteed interest is considered as 
interest paid or accrued.



Sec. 1.803-4   Taxable income and deductions.

    (a) In general. The taxable income of a life insurance company is 
its gross amount of income received or accrued during the taxable year 
from interest, dividends, and rents, less the deductions provided in 
section 803(g) for wholly tax-exempt interest, investment expenses, real 
estate expenses, depreciation, and the special deductions provided in 
part VIII (section 241 and following, except section 248), subchapter B, 
chapter 1 of the Code. In addition to the limitations on deductions 
relating to real estate owned and occupied by a life insurance company 
provided in section 803(h), the limitations on the adjustment for 
amortization of premium and accrual of discount provided in section 
803(i), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 803(g)(2), life insurance companies are subject to the 
limitations on deductions relating to wholly tax-exempt income provided 
in section 265. Life insurance companies are not entitled to the net 
operating loss deduction provided in section 172.
    (b) Wholly tax-exempt interest. Interest which in the case of other 
taxpayers is excluded from gross income by section 103 but included in 
the gross income of a life insurance company by section 803(a)(2) is 
allowed as a deduction from gross income by section 803(g)(1).
    (c) Investment expenses. (1) As used in the Code, the term general 
expenses means any expense paid or incurred for the benefit of more than 
one department of the company rather than for the benefit of a 
particular department thereof. Any assignment of such expense to the 
investment department of the company for which a deduction is claimed 
under section 803(g)(2) subjects the entire deduction for investment 
expenses to the limitation provided in that section. The accounting 
procedure employed is not conclusive as to whether any assignment has in 
fact been made. Investment expenses do not include Federal income and 
excess profits taxes.
    (2) If no general expenses are assigned to or included in investment 
expenses the deduction may consist of investment expenses paid or 
incurred during the taxable year in which case an itemized schedule of 
such expenses must be appended to the return.
    (3) Invested assets for the purpose of section 803(g)(2) and this 
section are those which are owned and used, and to the extent used, for 
the purpose of producing the income specified in section 803(a)(2). They 
do not include real estate owned and occupied, and to the extent owned 
and occupied, by the company. If general expenses are assigned to or 
included in investment expenses, the maximum allowance will not be 
granted unless it is shown to the satisfaction of the district director 
that such allowance is justified by a reasonable assignment of actual 
expenses.
    (d) Taxes and expenses with respect to real estate. The deduction 
for taxes and

[[Page 522]]

expenses under section 803(g)(3) includes taxes and expenses paid or 
accrued during the taxable year exclusively upon or with respect to real 
estate owned by the company and any sum representing taxes imposed upon 
a shareholder of the company upon his interest as shareholder which is 
paid or accrued by the company without reimbursement from the 
shareholder. No deduction shall be allowed, however, for taxes, 
expenses, and depreciation upon or with respect to any real estate owned 
by the company except to the extent used for the purpose of producing 
investment income. See paragraph (c) of this section. As to real estate 
owned and occupied by the company, see Sec. 1.803-5.
    (e) Depreciation. The deduction allowed for depreciation is, except 
as provided in section 803(h), identical with that allowed other 
corporations by section 167. The amount allowed by section 167 in the 
case of life insurance companies is limited to depreciation sustained on 
the property used, and to the extent used, for the purpose of producing 
the income specified in section 803(a)(2).



Sec. 1.803-5   Real estate owned and occupied.

    The amount allowable as a deduction for taxes, expenses, and 
depreciation upon or with respect to any real estate owned and occupied 
in whole or in part by a life insurance company is limited to an amount 
which bears the same ratio to such deduction (computed without regard to 
this limitation) as the rental value of the space not so occupied bears 
to the rental value of the entire property. For example, if the rental 
value of the space not occupied by the company is equal to one-half of 
the rental value of the entire property, the deduction for taxes, 
expenses, and depreciation is one-half of the taxes, expenses, and 
depreciation on account of the entire property. Where a deduction is 
claimed as provided in this section, the parts of the property occupied 
and the parts not occupied by the company, together with the respective 
rental values thereof, must be shown in a statement accompanying the 
return.



Sec. 1.803-6   Amortization of premium and accrual of discount.

    (a) Section 803(i) provides for certain adjustments on account of 
amortization of premium and accrual of discount on bonds, notes, 
debentures, or other evidences of indebtedness held by a life insurance 
company. Such adjustments are limited to the amount of appropriate 
amortization or accrual attributable to the taxable year with respect to 
such securities which are not in default as to principal or interest and 
which are amply secured. The question of ample security will be resolved 
according to the rules laid down from time to time by the National 
Association of Insurance Commissioners. The adjustment for amortization 
of premium decreases, and for accrual of discount increases, (1) the 
gross income, (2) the deduction for wholly tax-exempt interest, and (3) 
the deduction for partially tax-exempt interest.
    (b) The premium for any such security is the excess of its 
acquisition value over its maturity value and the discount is the excess 
of its maturity value over its acquisition value. The acquisition value 
of any such security is its cost (including buying commissions or 
brokerage but excluding any amounts paid for accrued interest) if 
purchased for cash, or if not purchased for cash, then its fair market 
value. The maturity value of any such security is the amount payable 
thereunder either at the maturity date or an earlier call date. The 
earlier call date of any such security may be the earliest call date 
specified therein as a day certain, the earliest interest payment date 
if it is callable or payable at such date, the earliest date at which it 
is callable at par, or such other call or payment date, prior to 
maturity, specified in the security as may be selected by the life 
insurance company. A life insurance company which adjusts amortization 
of premium or accrual of discount with reference to a particular call or 
payment date must make the adjustments with reference to the value on 
such date and may not, after selecting such date, use a different call

[[Page 523]]

or payment date, or value, in the calculation of such amortization or 
discount with respect to such security unless the security was not in 
fact called or paid on such selected date.
    (c) The adjustments for amortization of premium and accrual of 
discount will be determined:
    (1) According to the method regularly employed by the company, if 
such method is reasonable, or
    (2) According to the method prescribed by this section.

A method of amortization of premium or accrual of discount will be 
deemed ``regularly employed'' by a life insurance company if the method 
was consistently followed in prior taxable years, or if, in the case of 
a company which has never before made such adjustments, the company 
initiates in the first taxable year for which the adjustments are made a 
reasonable method of amortization of premium or accrual of discount and 
consistently follows such method thereafter. Ordinarily, a company 
regularly employs a method in accordance with the statute of some State, 
Territory, or the District of Columbia, in which it operates.
    (d) The method of amortization and accrual prescribed by this 
section is as follows:
    (1) The premium (or discount) shall be determined in accordance with 
this section; and
    (2) The appropriate amortization of premium (or accrual of discount) 
attributable to the taxable year shall be an amount which bears the same 
ratio to the premium (or discount) as the number of months in the 
taxable year during which the security was owned by the life insurance 
company bears to the number of months between the date of acquisition of 
the security and its maturity or earlier call date, determined in 
accordance with this section. For the purpose of this section, a 
fractional part of a month shall be disregarded unless it amounts to 
more than half a month, in which case it shall be considered as a month.



Sec. 1.803-7   Taxable years affected.

    Sections 1.803-1 through 1.803-6 are applicable only to taxable 
years beginning after December 31, 1953, and before January 1, 1955, and 
all references to sections of part I, subchapter L, chapter 1 of the 
Code are to the Internal Revenue Code of 1954, before amendments.

[T.D. 6513, 25 FR 12660, Dec. 10, 1960]

                            investment income



Sec. 1.804-3   Gross investment income of a life insurance company.

    (a) Gross investment income defined. For purposes of part I, 
subchapter L, chapter 1 of the Code, section 804(b) defines the term 
gross investment income of a life insurance company as the sum of the 
following:
    (1) The gross amount of income from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 818(b) and the regulations thereunder.
    (ii) Dividends, as described in Sec. 1.61-9.
    (iii) Rents and royalties, as described in Sec. 1.61-8.
    (iv) The entering into of any lease, mortgage, or other instrument 
or agreement from which the life insurance company may derive interest, 
rents, or royalties.
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph.

For example, gross investment income includes amounts received as 
commitment fees, as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage.
    (2) In the case of a taxable year beginning after December 31, 1958, 
the amount (if any) by which the net short-term capital gain (as defined 
in section 1222(5)) exceeds the net long-term capital loss (as defined 
in section 1222(8)), and
    (3) The gross income from any trade or business (other than an 
insurance business) carried on by the life insurance company, or by a 
partnership of which the life insurance company is a partner.
    (b) No double inclusion of income. In computing the gross income 
from any

[[Page 524]]

trade or business (other than an insurance business) carried on by the 
life insurance company, or by a partnership of which the life insurance 
company is a partner, any item described in section 804(b)(1) and 
paragraph (a)(1) of this section shall not be considered as gross income 
arising from the conduct of such trade or business or partnership, but 
shall be taken into account under section 804(b)(1) and paragraph (a)(1) 
of this section.
    (c) Exclusion of net long-term capital gains. Any net long-term 
capital gains from the sale or exchange of a capital asset (or any gain 
considered to be from the sale or exchange of a capital asset under 
applicable law) shall be excluded from the gross investment income of a 
life insurance company. However, section 804(b)(2) and paragraph (a)(2) 
of this section provide that the amount (if any) by which the net short-
term capital gain exceeds the net long-term capital loss shall be 
included in the gross investment income of a life insurance company.

[T.D. 6513, 25 FR 12661, Dec. 10, 1960]



Sec. 1.804-4   Investment yield of a life insurance company.

    (a) Investment yield defined. Section 804(c) defines the term 
``investment yield'' of a life insurance company for purposes of part I, 
subchapter L, chapter 1 of the Code. Investment yield means gross 
investment income (as defined in section 804(b) and paragraph (a) of 
Sec. 1.804-3), less the deductions provided in section 804(c) and 
paragraph (b) of this section for investment expenses, real estate 
expenses, depreciation, depletion, and trade or business (other than an 
insurance business) expenses. However, such expenses are deductible only 
to the extent that they relate to investment income and the deduction of 
such expenses is not disallowed by any other provision of subtitle A of 
the Code. For example, investment expenses are not allowable unless they 
are ordinary and necessary expenses within the meaning of section 162, 
and under section 265, no deduction is allowable for interest on 
indebtedness incurred or continued to purchase or carry obligations the 
interest on which is wholly exempt from taxation under chapter 1 of the 
Code. A deduction shall not be permitted with respect to the same item 
more than once.
    (b) Deductions from gross investment income--(1) Investment 
expenses. (i) Section 804(c)(1) provides for the deduction of investment 
expenses by a life insurance company in determining investment yield. 
``Investment expenses'' are those expenses of the taxable year which are 
fairly chargeable against gross investment income. For example, 
investment expenses include salaries and expenses paid exclusively for 
work in looking after investments, and amounts expended for printing, 
stationery, postage, and stenographic work incident to the collection of 
interest. An itemized schedule of such expenses shall be attached to the 
return.
    (ii) Any assignment of general expenses to the investment department 
of a life insurance company for which a deduction is claimed under 
section 804(c)(1) subjects the entire deduction for investment expenses 
to the limitation provided in that section and subdivision (iii) of this 
subparagraph. As used in section 804(c)(1), the term general expenses 
means any expense paid or incurred for the benefit of more than one 
department of the company rather than for the benefit of a particular 
department thereof. For example, if real estate taxes, depreciation, or 
other expenses attributable to office space owned by the company and 
utilized by it in connection with its investment function are assigned 
to investment expenses, such items shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 804(c)(1) and subdivision 
(iii) of this subparagraph. Similarly, if an expense, such as a salary, 
is attributable to more than one department, including the investment 
department, such expense may be properly allocated among these 
departments. If such expenses are allocated, the amount properly 
allocable to the investment department shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 804(c)(1) and subdivision 
(iii) of this subparagraph. If general expenses are

[[Page 525]]

in part assigned to or included in investment expenses, the maximum 
allowance (as determined under section 804(c)(1)) shall not be granted 
unless it is shown to the satisfaction of the district director that 
such allowance is justified by a reasonable assignment of actual 
expenses. The accounting procedure employed is not conclusive as to 
whether any assignment has in fact been made. Investment expenses do not 
include Federal income and excess profits taxes, if any. In cases where 
the investment expenses allowable as deductions under section 804(c)(1) 
exceed the limitation contained therein, see section 809(d)(9).
    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 804(c)(1) shall 
not exceed the sum of:
    (a) One-fourth of one percent of the mean of the assets (as defined 
in section 805(b)(4) and paragraph (a)(4) of Sec. 1.805-5) held at the 
beginning and end of the taxable year,
    (b) The amount of the mortgage service fees for the taxable year, 
plus
    (c) Whichever of the following is the greater:
    (1) One-fourth of the amount by which the investment yield (computed 
without any deduction for investment expenses allowed by section 
804(c)(1)) exceeds 3 3/4 percent of the mean of the assets (as defined 
in section 805(b)(4)) held at the beginning and end of the taxable year, 
reduced by the amount of the mortgage service fees for the taxable year, 
or
    (2) One-fourth of one percent of the mean of the value of mortgages 
held at the beginning and end of the taxable year for which there are no 
mortgage service fees for the taxable year. For purposes of the 
preceding sentence, the term mortgages held refers to mortgages, and 
other similar liens, on real property which are held by the company as 
security for ``mortgage loans''.

For purposes of section 804(c)(1)(B) and (C)(i) and (b) and (c)(1) of 
this subdivision, the term mortgage service fees includes mortgage 
origination fees. Such mortgage origination fees shall be amortized in 
accordance with the rules prescribed in section 818(b) and the 
regulations thereunder.
    (iv) The operation of the limitation contained in section 804(c)(1) 
and subdivision (iii) of this subparagraph may be illustrated by the 
following example:

    Example. The books of S, a life insurance company, reflect the 
following items for the taxable year 1958:

Investment expenses (including general expenses assigned                
 to or included in investment expenses)...................      $125,000
Mean of the assets held at the beginning and end of the                 
 taxable year.............................................    20,000,000
Mortgage service fees.....................................        25,000
Investment yield computed without regard to investment                  
 expenses.................................................     1,200,000
Mean of the value of mortgages held at the beginning and                
 end of the taxable year for which there are no mortgage                
 service fees.............................................     6,000,000
                                                                        

    In order to determine the limitation on investment expenses, S would 
make up the following schedule:

1. Mean of the assets held at the beginning                             
 and end of the taxable year................   $20,000,000              
                                             ---------------            
2. One-fourth of 1 percent of item 1 (1/4 of                            
 1% of $20,000,000).........................        50,000              
3. Mortgage service fees....................        25,000              
4. The greater of (a) or (b):                                           
(a)(i) Investment yield computed without                                
 regard to investment expenses..............    $1,200,000              
(ii) Three and three-fourths percent of item                            
 1 (3 3/4%  x  $20,000,000).................       750,000              
(iii) Excess of (i) over (ii) ($1,200,000                               
 minus $750,000)............................       450,000              
(iv) One-fourth of (iii) (1/4  x  $450,000).       112,500              
(v) Less: Mortgage service fees (item 3)....         25,00              
------------------------------------------------------------------------
(vi) Excess of (iv) over (v) ($112,500 minus                            
 $25,000)...................................        87,500              
------------------------------------------------------------------------
(b) One-fourth of 1 percent of the mean of the value of                 
 mortgages held at the beginning and end of the taxable                 
 year for which there are no mortgage service fees (1/4 of              
                                                                        
  1%  x  $6,000,000)........................        15,000              
5. The greater of item 4 (a) or (b).......................        87,500
                                             ---------------            
6. Limitation on investment expenses (items 2, 3, and                   
 4(a))....................................................       162,500
                                                                        

As the investment expenses (including general expenses assigned to or 
included in investment expenses) of S for the taxable year 1958 
($125,000) do not exceed the limitation on such expenses ($162,500), S 
would be entitled to deduct the entire $125,000 under section 804(c)(1).

    (2) Real estate expenses and taxes. The deduction for expenses and 
taxes under

[[Page 526]]

section 804(c)(2) includes taxes (as defined in section 164) and other 
expenses for the taxable year exclusively on or with respect to real 
estate owned by the company. For example, no deduction shall be allowed 
under section 804(c)(2) for amounts allowed as a deduction under section 
164(e) (relating to taxes of shareholders paid by a corporation). No 
deduction shall be allowed under section 804(c)(2) for any amount paid 
out for new buildings, or for permanent improvements or betterments made 
to increase the value of any property. An itemized schedule of such 
taxes and expenses shall be attached to the return. See subparagraph (4) 
of this paragraph for limitation of such deduction.
    (3) Depreciation. The deduction allowed for depreciation is, except 
as provided in section 804(c)(3) and subparagraph (4) of this paragraph, 
identical to that allowed other corporations by section 167. Such amount 
allowed as a deduction from gross investment income in determining 
investment yield is limited to depreciation sustained on the property 
used, and to the extent used, for the purpose of producing the income 
specified in section 804(b). An election with respect to any of the 
methods of depreciation provided in section 167 shall not be affected in 
any way by the enactment of the Life Insurance Company Income Tax Act of 
1959 (73 Stat. 112). However, in appropriate cases, the method of 
depreciation may be changed with the consent of the Commissioner. See 
section 167(e) and Sec. 1.167(e)-1. See subparagraph (4) of this 
paragraph for limitation of such deduction. See section 809(d)(12) and 
the regulations thereunder for the treatment of depreciable property 
used in the operation of a life insurance business.
    (4) Limitation on deductions allowable under section 804 (c)(2) and 
(c)(3). Section 804(c)(3) provides that the amount allowable as a 
deduction for taxes, expenses, and depreciation on or with respect to 
any real estate owned and occupied for insurance purposes in whole or in 
part by a life insurance company shall be limited to an amount which 
bears the same ratio to such deduction (computed without regard to this 
limitation) as the rental value of the space not so occupied bears to 
the rental value of the entire property. For example, T, a life 
insurance company, owns a twenty-story downtown home office building. 
The rental value of each floor of the building is identical. T rents 
nine floors to various tenants, one floor is utilized by it in operating 
its investment department, and the remaining ten floors are occupied by 
it in carrying on its insurance business. Since floor space equivalent 
to eleven-twentieths, or 55 percent, of the rental value of the entire 
property is owned and occupied for insurance purposes by the company, 
the deductions allowable under section 804(c)(2) and (3) for taxes, 
depreciation, and other real estate expenses shall be limited to nine-
twentieths, or 45 percent, of the taxes, depreciation, and other real 
estate expenses on account of the entire property. However, the portion 
of such allowable deductions attributable to the operation of the 
investment department (one-twentieth, or 5 percent) may be deductible as 
general expenses assigned to or included in investment expenses and as 
such shall be subject to the limitations of section 804(c)(1). Where a 
deduction is claimed as provided in this section, the parts of the 
property occupied and the parts not occupied by the company in carrying 
on its insurance business, together with the respective rental values 
thereof, must be shown in a schedule accompanying the return.
    (5) Depletion. The deduction for depletion (and depreciation) 
provided in section 804(c)(4) is identical to that allowed other 
corporations by section 611. The amount allowed by section 611 in the 
case of a life insurance company is limited to depletion (and 
depreciation) sustained on the property used, and to the extent used, 
for the purpose of producing the income specified in section 804(b). See 
section 611 and Sec. 1.611-5 for special rules relating to the 
depreciation of improvements in the case of mines, oil and gas wells, 
other natural deposits, and timber.
    (6) Trade or business deductions. (i) Under section 804(c)(5), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are attributable to any trade or business

[[Page 527]]

(other than an insurance business) carried on by the life insurance 
company, or by a partnership of which the life insurance company is a 
partner are, subject to the limitations in subdivisions (ii), (iii), and 
(iv) of this subparagraph, allowable as deductions from the gross 
investment income of a life insurance company in determining its 
investment yield. Such deductions are allowable, however, only to the 
extent that they are attributable to the production of income which is 
included in the life insurance company's gross investment income by 
reason of section 804(b)(3). However, since any interest, dividends, 
rents, and royalties received by any trade or business (other than an 
insurance business) carried on by the life insurance company, or by a 
partnership of which the life insurance company is a partner, is 
included in the life insurance company's gross investment income by 
reason of section 804(b)(1) and paragraph (b) of Sec. 1.804-3, any 
expenses fairly chargeable against the production of such income may be 
deductible under section 804(c) (1), (2), (3), or (4). The allowable 
deductions may exceed the gross income from such business.
    (ii) In computing the deductions under section 804(c)(5), there 
shall be excluded losses:
    (a) From (or considered as from) sales or exchanges of capital 
assets,
    (b) From sales or exchanges of property used in the trade or 
business (as defined in section 1231(b)), and
    (c) From the compulsory or involuntary conversion (as a result of 
destruction, in whole or in part, theft or seizure, or an exercise of 
the power of requisition or condemnation or the threat or imminence 
thereof) of property used in the trade or business (as so defined).
    (iii) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if a 
life insurance company operates a radio station primarily to advertise 
its own insurance services, a portion of the expenses of the radio 
station shall not be allowed as a deduction. The portion disallowed 
shall be an amount which bears the same ratio to the total expenses of 
the station as the value of advertising furnished to the insurance 
company bears to the total value of services rendered by the station.
    (iv) The deduction for net operating losses provided in section 172, 
and the special deductions for corporations provided in part VIII, 
subchapter B, chapter 1 of the Code, shall not be allowed.

[T.D. 6513, 25 FR 12662, Dec. 10, 1960]



Sec. 1.806-1   Adjustment for certain reserves.

    (a) For taxable years beginning after December 31, 1953, but before 
January 1, 1955, and ending after August 16, 1954, a life insurance 
company writing contracts other than life insurance or annuity contracts 
(either separately or combined with noncancellable health and accident 
insurance contracts) must add to its life insurance company taxable 
income (as a factor in determining 1954 adjusted taxable income) an 
amount equal to eight times the amount of the adjustment for certain 
reserves provided in paragraph (b) of this section.
    (b) The adjustment for certain reserves referred to in paragraph (a) 
of this section shall be an amount equal to 3 1/4 percent of the mean of 
the unearned premiums and unpaid losses at the beginning and end of the 
taxable year on such other contracts as are not included in life 
insurance reserves. If such unearned premiums, however, are less than 25 
percent of the net premiums written during the taxable year on such 
other contracts, then the adjustment shall be 3 1/4 percent of 25 
percent of the net premiums written during the taxable year on such 
other contracts plus 3 1/4 percent of the mean of the unpaid losses at 
the beginning and end of the taxable year on such other contracts. As 
used in this section, the term ``unearned premiums'' has the same 
meaning as in section 832(b)(4) andSec. 1.832-1.



Sec. 1.806-2   Taxable years affected.

    Section 1.806-1 is applicable only to taxable years beginning after 
December 31, 1953, and before January 1, 1955, and all references to 
sections of part I, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954, before amendments. Sections 1.806-3

[[Page 528]]

and 1.806-4 are applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6513, 25 FR 12668, Dec. 10, 1960]



Sec. 1.806-3   Certain changes in reserves and assets.

    (a) In general. For purposes of part I, subchapter L, chapter 1 of 
the Code, section 806(a) provides that if there is a change in life 
insurance reserves (as defined in section 801(b)), during the taxable 
year, which is attributable to the transfer between the taxpayer and 
another person of liabilities under contracts taken into account in 
computing such life insurance reserves, then the means of such reserves, 
and the mean of the assets, shall be appropriately adjusted to reflect 
the amounts involved in such transfer. For example, the adjustments 
required under section 806(a) are applicable to transfers in which one 
life insurance company purchases or acquires a part or all of the 
business of another life insurance company under an arrangement whereby 
the purchaser or transferee becomes solely liable on the contracts 
transferred. This provision shall apply in the case of assumption 
reinsurance but not in the case of indemnity reinsurance or reinsurance 
ceded. Thus, no adjustments shall be required under section 806(a) when, 
in the ordinary course of business, an indemnity reinsurance contract is 
entered into with another company (on a yearly renewable term basis, on 
a coinsurance basis, or otherwise) whereby there is a sharing of risks 
under one or more individual contracts. It will be necessary for each 
life insurance company participating in a transfer described in section 
806(a) to make the adjustments required by such section. Such 
adjustments shall be made without regard to whether or not the 
transferor of the liabilities was the original insurer.
    (b) Manner in which adjustments shall be made--(1) Daily basis. The 
means of the life insurance reserves, and the mean of the assets, shall 
be appropriately adjusted, on a daily basis, to reflect the amounts 
involved in a transfer described in section 806(a) and paragraph (a) of 
this section. The transferor and the transferee shall be treated as 
having held such life insurance reserves and assets for a fraction of 
the year in which the transfer occurs.
    (2) Determination of period held. In determining the fraction which 
represents the fractional year that such reserves and assets were held, 
the numerator shall be the number of days during the taxable year which 
such reserves and assets were actually held, and the denominator shall 
be the number of days in the calendar year of the transfer. In computing 
the period held for purposes of the numerator, the day on which such 
reserves and assets are transferred is included by the transferor and 
excluded by the transferee.
    (3) Adjustments to the means of life insurance reserves and assets 
not transferred. All life insurance reserves and assets transferred 
during the taxable year, within the meaning of section 806(a), shall be 
excluded from the beginning and end of the taxable year balances of the 
transferor and transferee, respectively. The amount of assets to be 
excluded from the beginning of the taxable year balance of the 
transferor shall be an amount equal to the value of such reserves at the 
beginning of the taxable year. The amount of assets to be excluded from 
the end of the taxable year balance of the transferee shall be an amount 
equal to the value of such reserves at the end of the taxable year. The 
means of the life insurance reserves and assets not so transferred shall 
be determined in the ordinary manner, that is, the arithmetic means. 
There shall be added to these means an amount to appropriately adjust 
them, on a daily basis, for the life insurance reserves and assets that 
were transferred during the taxable year. This adjustment shall be 
determined by multiplying (i) the mean of the transferred life insurance 
reserves (or assets, as the case may be) at the beginning of the taxable 
year (or, if acquired later, at the beginning of the period held as 
defined in subparagraph (2) of this paragraph) and the end of the period 
held as defined in subparagraph (2) of this paragraph (or

[[Page 529]]

at the end of the taxable year, if held at such time) by (ii) the 
fraction determined under subparagraph (2) of this paragraph.
    (4) Examples. The application of this paragraph may be illustrated 
by the following examples:

    Example 1. On March 14, 1958, the M Company, a life insurance 
company, transferred to the N Company, a life insurance company, 
pursuant to an assumption reinsurance agreement, all of its life 
insurance reserves, and related assets, on one block of policies. The 
reserves (and assets) for this block were held by the M Company on 
January 1, 1958, and totaled $60,000; on March 14, the reserves (and 
assets) totaled $64,000. The M Company had life insurance reserves of 
$1,000,000 at the beginning of 1958 (including those subsequently 
transferred) and $1,040,000 at the end of 1958. The M Company had assets 
of $1,300,000 at the beginning of 1958 (including those subsequently 
transferred) and $1,380,000 at the end of 1958. The mean of M's life 
insurance reserves for the taxable year 1958 is computed as follows:

Reserves at 1-1-58............................   $1,000,000             
  Exclude reserves (at beginning of year) on                            
   contracts transferred to N.................       60,000             
                                               -------------            
  Recomputed amount at 1-1-58..............................     $940,000
Reserves at 12-31-58.......................................    1,040,000
                                               --------------           
      Sum..................................................    1,980,000
                                               --------------           
      Mean.................................................      990,000
Adjustment for reserves transferred on 8-14-                            
 58:                                                                    
  Reserves at 1-1-58 on contracts transferred                           
   to N.......................................      $60,000             
  Reserves at 3-14-58 on such contracts.......       64,000             
                                               -------------            
      Sum.....................................      124,000             
                                               -------------            
      Mean....................................       62,000             
Fraction taken into account...................       73/365             
      Adjustment (73/365 x $62,000)........................      $12,400
                                               --------------           
Mean of M's life insurance reserves after section 806(a)                
 adjustment................................................    1,002,400
                                                                        

    Example 2. Assuming the facts to be the same as in example 1, the 
mean of M's assets for the taxable year 1958 is computed as follows:

Assets at 1-1-58..............................   $1,300,000             
  Exclude assets (at beginning of year) on                              
   contracts transferred to N.................       60,000             
                                               -------------            
      Recomputed amount at 1-1-58..........................   $1,240,000
Assets at 12-31-58.........................................    1,380,000
                                               --------------           
      Sum..................................................    2,620,000
                                               --------------           
      Mean.................................................    1,310,000
Adjustments for assets transferred on 3-14-58:                          
  Assets at 1-1-58 on contracts transferred to                          
   N..........................................      $60,000             
  Assets at 3-14-58 on such contracts.........       64,000             
                                               -------------            
      Sum.....................................      124,000             
                                               -------------            
      Mean....................................       62,000             
                                               -------------            
Fraction taken into account...................       73/365             
      Adjustment (73/365 x $62,000)-.......................      $12,400
                                               --------------           
Mean of M's assets after section 806(a) adjustment.........    1,322,400
                                                                        

    Example 3. Assume the facts are the same as in example 1. At the end 
of 1958, N Company had life insurance reserves (and assets) of $80,000 
on the contracts transferred on March 14, 1958. The N Company had life 
insurance reserves of $6,000,000 at the beginning of 1958 and $6,400,000 
at the end of 1958 (including those transferred). The N Company had 
assets of $6,800,000 at the beginning of 1958 and $7,300,000 at the end 
of 1958 (including those on the contracts transferred). The mean of N's 
life insurance reserves for the taxable year 1958 is computed as 
follows:

Reserves at 1-1-58.........................................   $6,000,000
Reserves at 12-31-58..........................   $6,400,000             
  Exclude reserves (at end of year) on                                  
   contracts transferred from M...............       80,000             
                                               -------------            
      Recomputed amount at 12-31-58........................    6,320,000
                                               --------------           
      Sum..................................................   12,320,000
                                               --------------           
      Mean.................................................   6,160,000 
Adjustment for reserves transferred on 3-14-                            
 58:                                                                    
  Reserves at 3-14-58 on contracts transferred                          
   from M.....................................      $64,000             
  Reserves at 12-31-58 on such contracts......       80,000             
                                               -------------            
      Sum.....................................      144,000             
                                               -------------            
      Mean....................................       72,000             
Fraction taken into account...................      292/365             
      Adjustment (292/365 x $72,000).......................       57,600
                                               --------------           
Mean of N's life insurance reserves after section 806(a)                
 adjustment................................................    6,217,600
                                                                        

    Example 4. Assuming the facts to be the same as in example 3, the 
mean of N's assets for the taxable year 1958 is computed as follows:

Assets at 1-1-58...........................................   $6,800,000
Assets at 12-31-58............................   $7,300,000             
  Exclude assets (at end of year) on contracts                          
   transferred from M.........................       80,000             
                                               -------------            
      Recomputed amount at 12-31-58........................    7,220,000
                                               --------------           
      Sum..................................................   14,020,000
                                               --------------           
      Mean.................................................    7,010,000

[[Page 530]]

                                                                        
Adjustments for assets transferred on 3-14-58:                          
Assets at 3-14-58 on contracts transferred                              
 from M.......................................      $64,000             
Assets at 12-31-58 on such contracts..........       80,000             
                                               -------------            
      Sum.....................................      144,000             
                                               -------------            
      Mean....................................       72,000             
                                               -------------            
Fraction taken into account...................      292/365             
  Adjustment (292/365 x $72,000)...........................      $57,600
                                               --------------           
Mean of N's assets after section 806(a) adjustment.........    7,067,600
                                                                        

    Example 5. The facts are the same as in example 1, except that on 
October 19, 1958, company N transfers to company P, a life insurance 
company, all of the life insurance reserves, and related assets, on the 
block of policies it had received from company M on March 14, 1958. The 
reserves (and assets) for this block totaled $76,000 on October 19, 
1958. The means of company M's life insurance reserves and assets, as 
computed in examples 1 and (2), respectively, would be unchanged by the 
transfer of October 19, 1958. Since company N did not own this block of 
policies at either the beginning or end of the taxable year, it would 
not have to recompute its beginning or end of the taxable year reserves 
or assets. Company N will, however, have to adjust (or increase) the 
mean of its life insurance reserves and assets on account of the 
policies it received from company M. This adjustment will be $42,000, 
which is determined by multiplying the means of the life insurance 
reserves (or assets) on these policies as of March 15, 1958, and October 
19, 1958, $70,000 ($64,000+$76,000=$140,0002) by the fraction 
219/365 (the numerator of 219 is determined by excluding the day of the 
transfer to N, March 14, 1958, and including the day of the transfer 
from N to P, October 19, 1958). Company P will have to recompute its end 
of the year life insurance reserves and assets (in the same manner as 
illustrated in examples 3 and 4). Assuming the end of the year reserves 
(and assets) on this block of policies is $80,000, company P will have 
an adjustment under section 806 (a) of $15,600, which is determined by 
multiplying the means of the reserves on these policies as of October 
20, 1958, and December 31, 1958, $78,000 ($76,000+$80,000= 
$156,0002) by the fraction 73/365.

[T.D. 6513, 25 FR 12663, Dec. 10, 1960]



Sec. 1.806-4   Change of basis in computing reserves.

    (a) In general. For purposes of subpart B, part I, subchapter L, 
chapter 1 of the Code, section 806(b) provides that if the basis for 
determining the amount of any item referred to in section 810(c) 
(relating to items taken into account) as of the close of the taxable 
year differs from the basis for such determination as of the beginning 
of the taxable year, then in determining taxable investment income the 
amount of the item as of the close of the taxable year shall be the 
amount computed on the old basis, and the amount of the item as of the 
beginning of the next taxable year shall be the amount computed on the 
new basis. For purposes of the preceding sentence, an election under 
section 818(c) shall not be treated as a change in basis for determining 
the amount of an item referred to in section 810(c). A change of basis 
in computing any of the items referred to in section 810(c) is not a 
change of accounting method requiring the consent of the Secretary or 
his delegate under section 446(e).
    (b) Illustration of change of basis in computing reserves. The 
application of section 806(b) and paragraph (a) of this section may be 
illustrated by the following examples:

    Example 1. Assume that the life insurance reserves of Y, a life 
insurance company, at the beginning of the taxable year 1959 are $100 
and that during such taxable year a portion of the reserves is 
strengthened (by reason of a change in mortality or interest 
assumptions, or otherwise), so that at the end of the taxable year 1959 
the reserves (computed on the new basis) are $130 but computed on the 
old basis would be $120. Assume further that at the close of the next 
taxable year, 1960, the reserves (computed on the new basis) are $142. 
Under the provisions of section 806(b) and paragraph (a) of this 
section, the mean of such reserves for the taxable year of the reserve 
strengthening, namely 1959, is $110 (the mean of $100, the balance at 
the beginning of the taxable year 1959, and $120, the balance at the end 
of the taxable year 1959 computed on the old basis). The mean of such 
reserves for the next taxable year, 1960, is $136 (the mean of $130, the 
balance at the beginning of the taxable year 1960 computed on the new 
basis, and $142, the balance at the end of the taxable year 1960 
computed on the new basis).
    Example 2. The life insurance reserves of S, a life insurance 
company, computed with respect to contracts for which such reserves are 
determined on a recognized preliminary term basis amount to $50 on 
January 1, 1959, and $80 on December 31, 1959. For the taxable year 
1959, S elects to revalue such reserves on a net level premium basis 
under section 818(c). Such reserves computed under section 818(c) amount 
to $60 on January 1, 1959, and

[[Page 531]]

$96 on December 31, 1959. Under the provisions of paragraph (a) of this 
section, the mean of such reserves for the taxable year 1959 is $78 (the 
mean of $60, the balance at the beginning of the taxable year 1959 
computed under section 818(c), and $96, the balance at the end of the 
taxable year 1959 computed under section 818(c).

[T.D. 6513, 25 FR 12669, Dec. 10, 1960]



Sec. 1.807-1  Mortality and morbidity tables.

    (a) Tables to be used. If there are no commissioners' standard 
tables applicable to an insurance contract when the contract is issued, 
then the mortality and morbidity tables set forth in this subsection are 
used to compute reserves under section 807(d)(2) for the contract.

------------------------------------------------------------------------
             Type of Contract                           Table           
------------------------------------------------------------------------
1. Group term life insurance (active life   1960 Commissioners' Standard
 reserves).                                  Group Mortality Table.     
2. Group life insurance (active life        1959 Accidental Death       
 reserves); accidental death benefits.       Benefits Table.            
3. Permanent and paid-up group life         Same table as are applicable
 insurance (active life reserves).           to males for ordinary life 
                                             insurance.                 
4a. Group life insurance disability income  The tables of period 2      
 benefits (active life reserves).            disablement rates and the  
                                             1930 to 1950 termination   
                                             rates of the 1952          
                                             Disability Study of the    
                                             Society of Actuaries.      
4b. Group life insurance disability income  The 1930 to 1950 termination
 benefits (disabled life reserves).          rates of the 1952          
                                             Disability study of the    
                                             Society of Actuaries.      
5. Group life insurance; survivor income    Same tables as are          
 benefits insurance.                         applicable to group        
                                             annuities.                 
6. Group life insurance; extended death     1970 Intercompany Group life
 benefits for disabled lives.                Disability Valuation Table.
7. Credit life insurance..................  1958 Commissions' Extended  
                                             Term Table.                
8. Supplementary contracts involving life   Same tables as are          
 contingencies.                              applicable to individual   
                                             immediate annuities.       
9. Noncancellable accident and health       Tables used for NAIC annual 
 insurance (active life reserves);           statement reserves as of   
 benefits issued before 1984.                December 31, 1983.         
10a. Noncancellable accident and health     1964 Commissioners'         
 insurance (active life reserves); group     Disability Tables.         
 disability benefits issued after 1983 and                              
 individual disability benefits issued                                  
 after 1983 and before 1989.                                            
10b. Noncancellable accident and health     1985 Commissioners'         
 insurance (active life reserves);           Individual Disability Table
 individual disability benefits issued       A or Commissioners'        
 after 1988.                                 Individual Disability Table
                                             B.                         
11. Noncancellable accident and health      1959 Accidental Death       
 insurance (active life reserves);           Benefits Tables.           
 accidental death benefits issued after                                 
 1983.                                                                  
12. Noncancellable accident and health      Tables used for NAIC annual 
 insurance (active life reserves); all       statement reserves.        
 benefits issued after 1983 other than                                  
 disability and accidental death.                                       
13a. Noncancellable accident and health     1964 Commissioners'         
 insurance (claim reserves); group           Disability Tables.         
 disability benefits for all years of                                   
 issue and individual disability benefits                               
 for years before 1989.                                                 
13b. Noncancellable accident and health     1985 Commissioners'         
 insurance (claim reserves); individual      Individual Disability Table
 disability benefits for years after 1988.   A or Commissioners'        
                                             Individual Disability Table
                                             B.                         
14. Noncancellable accident and health      Tables used for annual      
 insurance (claim reserves); all benefits    statement reserves.        
 other than disability for all years of                                 
 issue.                                                                 
------------------------------------------------------------------------

    (b) Adjustments. An appropriate adjustment may be made to the tables 
in paragraph (a) of this section to reflect risks (such as substandard 
risks) incurred under the contract which are not otherwise taken into 
account.
    (c) Special rule where more than 1 table or option applicable. If, 
with respect to any category of risks, there are 2 or more tables (or 
options under 1 or more tables) in paragraph (a) of this section, the 
table (and option thereunder) which generally yields the lowest reserves 
shall be used to compute reserves under section 807(d)(2) for the 
contract.
    (d) Effective date. This section is effective for taxable years 
beginning after December 31, 1983, except that the 1985 Commissioners' 
Individual Disability Tables A and B shall be treated (for purposes of 
section 807(d)(5)(B) and for purposes of determining the issue dates of 
contracts for which they shall be used) as if the tables were new 
prevailing commissioners' standard tables adopted by the twenty-sixth 
State on December 26, 1989.

[T.D. 8278, 54 FR 52934, Dec. 26, 1989; 55 FR 1768, Jan. 18, 1990]

[[Page 532]]

                      Gain and Loss From Operations



Sec. 1.809-1   Taxable years affected.

    Sections 1.809 through 1.809-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all reference to sections of part I, subchapter L, chapter 
1 of the Code are to the Internal Revenue Code of 1954, as amended by 
the Life Insurance Company Income Tax Act of 1959 (73 Stat. 112), the 
Act of June 27, 1961 (75 Stat. 120), the Act of October 10, 1962 (76 
Stat. 808); the Act of October 23, 1962 (76 Stat. 1134), and section 
214(b)(4) of the Revenue Act of 1964 (78 Stat. 55).

[T.D. 6992, 34 FR 827, Jan. 18, 1969]



Sec. 1.809-2   Exclusion of share of investment yield set aside for policyholders.

    (a) In general.  Section 809 provides the rules for determining the 
gain or loss from operations of a life insurance company, which amount 
is necessary to determine life insurance company taxable income. In 
order to determine gain or loss from operations, a life insurance 
company must first determine the share of each and every item of its 
investment yield (as defined in section 804(c) and paragraph (a) of 
Sec. 1.804-4) set aside for policyholders (as computed under section 
809(a)(1) and paragraph (b) of this section), as this share is excluded 
from gain or loss from operations (as defined in section 809(b) (1) and 
(2) and paragraphs (a) and (b) of Sec. 1.809-3, respectively). The life 
insurance company shall then add its share of each and every item of its 
investment yield to the sum of the items comprising gross amount (as 
described in section 809(c) and paragraph (a) of Sec. 1.809-4). In 
addition, the life insurance company shall, for taxable years beginning 
after December 31, 1961, add the amount (if any) by which its net long-
term capital gain exceeds its net short-term loss. From the sum so 
computed (which includes the capital gains item only for taxable years 
beginning after December 31, 1961) there shall then be subtracted the 
deductions provided in section 809(d) and paragraph (a) of Sec. 1.809-5. 
The amount thus obtained is the gain or loss from operations for the 
taxable year.
    (b) Computation of share of investment yield set aside for 
policyholders.  Section 809(a)(1) provides that the share of each and 
every item of investment yield (including tax-exempt interest, partially 
tax-exempt interest, and dividends received) of any life insurance 
company set aside for policyholders shall not be included in gain or 
loss from operations. For this purpose, the percentage used in 
determining the share of each of these items comprising the investment 
yield set aside for policyholders shall be determined by dividing the 
required interest (as defined in section 809(a)(2) and paragraph (d) of 
this section) by the investment yield (as defined in section 804(c) and 
paragraph (a) of Sec. 1.804-4). The percentage thus obtained is then 
applied to each and every item of the investment yield so that the share 
of each and every item of investment yield set aside for policyholders 
shall be excluded from gain or loss from operations. However, if in any 
case the required interest exceeds the investment yield, then the share 
of any item set aside for policyholders shall be 100 percent.
    (c) Computation of life insurance company's share of investment 
yield. For purposes of subpart C, part I, subchapter L, chapter 1 of the 
Code, section 809(b)(3) provides that the percentage used in determining 
the life insurance company's share of each and every item of investment 
yield (including tax-exempt interest, partially tax-exempt interest, and 
dividends received) shall be obtained by subtracting the percentage 
obtained under paragraph (b) of this section from 100 percent. For 
example, if the policyholders' percentage (as determined under section 
809(a)(1) and paragraph (b) of this section) is 72.38 percent, then the 
life insurance company's share is 27.62 percent (100 percent minus 72.38 
percent). In such a case, if the amount of a particular item is $200, 
then the life insurance company's share of such item included in 
determining gain or loss from operations is $55.24 ($200 multiplied by 
27.62 percent) and the share of such item set aside for policyholders 
(which is excluded from gain or loss from operations) is $144.76 ($200 
multiplied by 72.38 percent). For purposes of

[[Page 533]]

determining gain or loss from operations, the life insurance company's 
share of each and every item of investment yield (including tax-exempt 
interest, partially tax-exempt interest, and dividends received) shall 
be added to the sum of the items comprising gross amount (as described 
in section 809(c) and paragraph (a) of Sec. 1.809-4).
    (d) Required interest defined. (1) For purposes of part I, section 
809(a)(2) defines the term required interest for any taxable year as the 
sum of the products obtained by multiplying (i) each rate of interest 
required, or assumed by the taxpayer, in calculating the reserves 
described in section 810(c), by (ii) the means of the amount of such 
reserves computed at that rate at the beginning and end of the taxable 
year. In the case of the reserves described in section 810(c)(1), such 
rate of interest shall be the same as that used by the taxpayer for 
purposes of paragraph (b) of Sec. 1.801-5 (relating to the definition of 
reserves required by law) with respect to such reserves. In the case of 
the reserves described in section 810(c)(2) through (5), such rate of 
interest shall be the same as that actually paid, credited, or accrued 
by the taxpayer with respect to such reserves. Thus, the required 
interest for any taxable year includes the elements of interest paid (as 
defined in section 805(e)) with respect to the reserves described in 
section 810(c).
    (2) For purposes of computing required interest under section 
809(a)(2) and subparagraph (1) of this paragraph, the amount of life 
insurance reserves taken into account shall be adjusted first as 
required by section 818(c) (relating to an election with respect to life 
insurance reserves computed on a preliminary term basis) and then as 
required by section 806(a) (relating to adjustments for certain changes 
in reserves and assets) before applying the rate of interest required, 
or assumed by the taxpayer, thereto. However, in the case of the 
adjustments required by section 810(d) as a result of a change in the 
basis of computing reserves, the adjustments to any of the reserves 
described in section 810(c) shall be taken into account in accordance 
with the rules prescribed in section 810(d) and Sec. 1.810-3.

[T.D. 6535, 26 FR 525, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8687, June 23, 1966]



Sec. 1.809-3   Gain and loss from operations defined.

    (a) Gain from operations. For purposes of part I, subchapter L, 
chapter 1 of the Code, section 809(b)(1) defines the term gain from 
operations as the excess of the sum of (1) the life insurance company's 
share of each and every item of investment yield (including tax-exempt 
interest, partially tax-exempt interest, and dividends received), (2) 
the items of gross amount taken into account under section 809(c) and 
paragraph (a) of Sec. 1.809-4, and (3) for taxable years beginning after 
December 31, 1961, the amount (if any) by which the net long-term 
capital gain exceeds the net short-term capital loss, over the sum of 
the deductions provided by section 809(d) and Sec. 1.809-5.
    (b) Loss from operations. For purposes of part I, section 809(b)(2) 
defines the term loss from operations as the excess of the sum of the 
deductions provided by section 809(d) and Sec. 1.809-5 over the sum of 
(1) the life insurance company's share of each and every item of 
investment yield (including tax-exempt interest, partially tax-exempt 
interest, and dividends received), (2) the items of gross amount taken 
into account under section 809(c) and paragraph (a) of Sec. 1.809-4, and 
(3) for taxable years beginning after December 31, 1961, the amount (if 
any) by which the net long-term capital gain exceeds the net short-term 
capital loss.
    (c) Illustration of principles. The provisions of section 809(b) (1) 
through (3) and paragraphs (a) and (b) of this section may be 
illustrated by the following example:

     Example. For the taxable year 1958, T, a life insurance company, 
had investment yield of $900,000, including $150,000 of dividends 
received from domestic corporations subject to taxation under chapter 1 
of the Code, $10,000 of wholly tax-exempt interest, and $78,000 of 
partially tax-exempt interest. T also had items of gross amount under 
section 809(c) in the amount of $12,000,000 and deductions under section 
809(d) of $6,963,500 (exclusive of any deductions for wholly tax-exempt 
interest, partially tax-exempt interest, and dividends received). For 
such taxable year, the

[[Page 534]]

share of each and every item of investment yield set aside for 
policyholders was 80 percent and the company's share of each and every 
item of investment yield was 20 percent. Based upon these figures, T had 
a gain from operations of $5,180,000 for the taxable year 1958, computed 
as follows:

------------------------------------------------------------------------
                                              Col. 2 (80% x  Col. 3 (20%
                                                 Col. 1)      x Col. 1) 
                                    Col. 1    exclusion of    company's 
                                             policyholder's     share   
                                                  share                 
------------------------------------------------------------------------
Interest wholly tax-exempt......    $10,000        $8,000        $2,000 
Interest partially tax-exempt...     78,000        62,400        15,600 
Dividends received..............     50,000       120,000        30,000 
Other items of investment yield.    662,000       529,600       132,400 
    Investment yield............    900,000       720,000       180,000 
------------------------------------------------------------------------


Gross amount (sum of items under sec.                                   
 809(c))...................................                  $12,000,000
                                                         ---------------
    Total..................................                   12,180,000
Less:                                                                   
  Deductions under sec. 809(d)(8):                                      
    Company's share of interest wholly tax-                             
     exempt................................       $2,000                
     30/52 of company's share of interest                               
     partially tax-exempt (30/52  x                                     
     $15,600)..............................        9,000                
    85% of company's share of dividends                                 
     received (but not to exceed 85% of                                 
     gain from operations as computed under                             
     sec. 809(d)(8)(B)) (85% x $30,000)....       25,500                
All other deductions under sec. 809(d)         6,963,500                
                                            -------------               
                                                               7,000,000
                                                         ---------------
      Gain from operations..............................       5,180,000
                                                                        

    (d) Exception. (1) In accordance with section 809(b)(4), if it is 
established in any case to the satisfaction of the Commissioner, or by a 
determination of The Tax Court of the United States, or of any other 
court of competent jurisdiction, which has become final, that the 
application of the definition of gain from operations contained in 
section 809(b)(1) results in the imposition of tax on:
    (i) Any interest which under section 103 is excluded from gross 
income,
    (ii) Any amount of interest which under section 242 (as modified by 
section 804(a)(3)) is allowable as a deduction, or
    (iii) Any amount of dividends received which under sections 243, 
244, and 245 (as modified by section 809(d)(8)(B)) is allowable as a 
deduction,

adjustment shall be made to the extent necessary to prevent such 
imposition.
    (2) For the date upon which a decision by the Tax Court becomes 
final, see section 7481. For the date upon which a judgment of any other 
court becomes final, see paragraph (c) of Sec. 1.1313(a)-1.

[T.D. 6535, 26 FR 526, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8687, June 28, 1966]



Sec. 1.809-4   Gross amount.

    (a) Items taken into account. For purposes of determining gain or 
loss from operations under section 809(b) (1) and (2), respectively, 
section 809(c) specifies three categories of items which shall be taken 
into account. Such items are in addition to the life insurance company's 
share of the investment yield (as determined under section 809(a)(1) and 
paragraph (c) of Sec. 1.809-2), and the amount (if any) by which the net 
long-term capital gain exceeds the net short-term capital loss (such 
capital gains item is included in determining gain or loss from 
operations only for taxable years beginning after December 31, 1961). 
The additional three categories of items taken into account are:
    (1) Premiums. (i) The gross amount of all premiums and other 
consideration on insurance and annuity contracts (including contracts 
supplementary thereto); less return premiums and premiums and other 
consideration arising out of reinsurance ceded. The term gross amount of 
all premiums means the premiums and other consideration provided in the 
insurance or annuity contract. Thus, the amount to be taken into account 
shall be the total of the premiums and other consideration provided in 
the insurance or annuity contract without any deduction for commissions, 
return premiums, reinsurance, dividends to policyholders, dividends left 
on deposit with the company, discounts on premiums paid in advance, 
interest applied in reduction of premiums (whether or not required

[[Page 535]]

to be credited in reduction of premiums under the terms of the 
contract), or any other item of similar nature. Such term includes 
advance premiums, premiums deferred and uncollected and premiums due and 
unpaid, deposits, fees, assessments, and consideration in respect of 
assuming liabilities under contracts not issued by the taxpayer (such as 
a payment or transfer of property in an assumption reinsurance 
transaction as defined in paragraph (a)(7)(ii) of Sec. 1.809-5). The 
term also includes amounts a life insurance company charges itself 
representing premiums with respect to liability for insurance and 
annuity benefits for its employees (including full-time life insurance 
salesmen within the meaning of section 7701(a)(20)).
    (ii) The term return premiums means amounts returned or credited 
which are fixed by contract and do not depend on the experience of the 
company or the discretion of the management. Thus, such term includes 
amounts refunded due to policy cancellations or erroneously computed 
premiums. Furthermore, amounts of premiums or other consideration 
returned to another life insurance company in respect of reinsurance 
ceded shall be included in return premiums. For the treatment of amounts 
which do not meet the requirements of return premiums, see section 811 
(relating to dividends to policyholders).
    (iii) For purposes of section 809(c)(1) and this subparagraph, the 
term reinsurance ceded means an arrangement whereby the taxpayer (the 
reinsured) remains solely liable to the policyholder, whether all or 
only a portion of the risk has been transferred to the reinsurer. Such 
term includes indemnity reinsurance transactions but does not include 
assumption reinsurance transactions. See paragraph (a)(7)(ii) of 
Sec. 1.809-5 for the definition of assumption reinsurance.
    (2) Decreases in certain reserves. Each net decrease in reserves 
which is required by section 810 (a) and (d)(1) or 811(b)(2) to be taken 
into account for the taxable year as a net decrease for purposes of 
section 809(c)(2).
    (3) Other amounts. All amounts, not included in computing investment 
yield and not otherwise taken into account under section 809(c) (1) or 
(2), shall be taken into account under section 809(c)(3) to the extent 
that such amounts are includible in gross income under subtitle A of the 
Code. See section 61 (relating to gross income defined) and the 
regulations thereunder.
    (b) Treatment of net long-term capital gains. For taxable years 
beginning before January 1, 1962, any net long-term capital gains (as 
defined in section 1222(7)) from the sale or exchange of a capital asset 
(or any gain considered to be from the sale or exchange of a capital 
asset under applicable law) shall be excluded from the determination of 
gain or loss from operations of a life insurance company. On the other 
hand, with respect to taxable years beginning after December 31, 1961, 
the amount (if any) by which the net long-term capital gain exceeds the 
net short-term capital loss (as defined in section 1222(6)) shall be 
taken into account in determining gain or loss from operations under 
section 809. However, for any taxable year beginning after December 31, 
1958, the excess of net short-term capital gain (as defined in section 
1222(5)) over net long-term capital loss (as defined in section 1222(8)) 
is included in computing investment yield (as defined in section 804(c)) 
and, to that extent, is taken into account in determining gain or loss 
from operations under section 809.

[T.D. 6535, 26 FR 527, Jan. 20, 1961, as amended by T.D. 6610, 27 FR 
8718, Aug. 31, 1962, T.D. 6886, 31 FR 8687, June 23, 1966]



Sec. 1.809-5   Deductions.

    (a) Deductions allowed. Section 809(d) provides the following 
deductions for purposes of determining gain or loss from operations 
under section 809(b) (1) and (2), respectively:
    (1) Death benefits, etc. All claims and benefits accrued (less 
reinsurance recoverable), and all losses incurred (whether or not 
ascertained), during the taxable year on insurance and annuity contracts 
(including contracts supplementary thereto). The term all claims and 
benefits accrued includes, for example, matured endowments and amounts 
allowed on surrender. The term losses incurred (whether or not 
ascertained) includes a reasonable estimate of the amount of the losses 
(based

[[Page 536]]

upon the facts in each case and the company's experience with similar 
cases) incurred but not reported by the end of the taxable year as well 
as losses reported but where the amount thereof cannot be ascertained by 
the end of the taxable year.
    (2) Increases in certain reserves. The net increase in reserves 
which is required by section 810 (b) and (d)(1) to be taken into account 
for the taxable year as a net increase for purposes of section 
809(d)(2).
    (3) Dividends to policyholders. The deduction for dividends to 
policyholders as determined under section 811(b) and Sec. 1.811-2. 
Except as provided in section 809(d)(3) and this subparagraph, no amount 
shall be allowed as a deduction in respect of dividends to policyholders 
under section 809(d). See section 809(f) and Sec. 1.809-7 for limitation 
of such deduction.
    (4) Operations loss deduction. The operations loss deduction as 
determined under section 812.
    (5) Certain nonparticipating contracts. (i) An amount equal to the 
greater of:
    (a) 10 percent of the increase for the taxable year in certain life 
insurance reserves for nonparticipating contracts (other than group 
contracts); or
    (b) 3 percent of the premiums for the taxable year attributable to 
nonparticipating contracts (other than group contracts) which are issued 
or renewed for periods of 5 years or more.
    (ii) For purposes of section 809(d)(5) and this subparagraph, the 
term nonparticipating contracts means those contracts which during the 
taxable year contain no right to participate in the divisible surplus of 
the company. For example, if at any time during the taxable year for 
which the deduction allowed under section 809(d)(5) and this 
subparagraph is claimed such contracts have rights to dividends or 
similar distributions (as defined in section 811(a) and paragraph (a) of 
Sec. 1.811-2), such contracts shall no longer be deemed nonparticipating 
contracts and, therefore, no deduction shall be allowed. Thus, if a 
class of contracts having no right to participate in the divisible 
surplus of the company is in force for nine years and on March 10, 1958, 
it is announced that such contracts shall be accorded dividend rights as 
of August 1, 1958, no deduction shall be allowed under section 809(d)(5) 
and this subparagraph for the taxable year 1958 or any succeeding 
taxable year, whether or not dividends are actually paid on such 
contracts. However, if the announcement of March 10, 1958, states that 
such contracts shall be accorded dividend rights as of January 1, 1959, 
a deduction under section 809(d)(5) and this subparagraph shall be 
allowed for the taxable year 1958 but not for any succeeding taxable 
year.
    (iii) For purposes of section 809(d)(5) and this subparagraph, the 
term reserves for nonparticipating contracts means such part of the life 
insurance reserves (as defined in section 801(b) and Sec. 1.801-4), 
other than that portion of such reserves which is allocable to annuity 
features, as relates to nonparticipating contracts (as defined in 
subdivision (ii) of this subparagraph). The amount of life insurance 
reserves taken into account shall be adjusted first as required by 
section 818(c) (relating to an election with respect to life insurance 
reserves computed on a preliminary term basis) and then as required by 
section 806(a) (relating to adjustments for certain changes in reserves 
and assets). In the case of the adjustments required by section 810(d) 
(relating to adjustment for change in computing reserves), the increase 
in life insurance reserves attributable to reserve strengthening shall 
be taken into account in accordance with the rules prescribed in section 
810(d) and Sec. 1.810-3.
    (iv) For purposes of section 809(d)(5) and this subparagraph, the 
term premiums means the net amount of the premiums and other 
consideration attributable to nonparticipating contracts (as defined in 
subdivision (ii) of this subparagraph) which are taken into account 
under section 809(c)(1). For this purpose, premiums include only such 
amounts attributable to such contracts which are issued or renewed for 
periods of 5 years or more, but does not include that portion of the 
premiums which is allocable to annuity features. No portion of a premium 
shall be deemed allocable to annuity features solely because a contract, 
such as an endowment contract, provides that at maturity the insured 
shall have an

[[Page 537]]

option to take an annuity. The determination of whether a contract meets 
the 5-year requirement shall be made as of the date the contract is 
issued, or as of the date it is renewed, whichever is applicable. Thus, 
a 20-year nonparticipating endowment policy shall qualify for the 
deduction under section 809(d)(5), even though the insured subsequently 
dies at the end of the second year, since the policy is issued for a 
period of 5 years or more. However, a 1-year renewable term contract 
shall not qualify, since as of the date it is issued (or of any renewal 
date) it is not issued (or renewed) for a period of 5 years or more. In 
like manner, a policy originally issued for a 3-year period and 
subsequently renewed for an additional 3-year period shall not qualify. 
However, if this policy is renewed for a period of 5 years or more, the 
policy shall qualify for the deduction under section 809(d)(5) from the 
date it is renewed.
    (v) The provisions of section 809(d)(5) and this subparagraph may be 
illustrated by the following example:

     Example. Assume the following facts with respect to X, a life 
insurance company, for the taxable year 1958:


Life insurance reserves on nonparticipating contracts                   
 without annuity features (other than group contracts) at 1-            
 1-58.......................................................    $150,000
Life insurance reserves on nonparticipating contracts                   
 without annuity features (other than group contracts) at 12-           
 31-58......................................................     225,000
Annuity reserves on nonparticipating contracts (other than              
 group contracts) at 1-1-58.................................      48,000
Annuity reserves on nonparticipating contracts (other than              
 group contracts) at 12-31-58...............................      57,000
Premiums on nonparticipating contracts without annuity                  
 features (other than group contracts) issued or renewed for            
 5 years or more............................................      85,000
Premiums on nonparticipating contracts allocable to annuity             
 features (other than group contracts) issued or renewed for            
 5 years or more............................................      14,000
Return premiums on nonparticipating contracts without                   
 annuity features (other than group contracts)..............       5,000
                                                                        

In order to determine the deduction under section 809(d)(5) (without 
regard to the limitation of section 809(f)), X would make up the 
following schedule:

(1) Life insurance reserves on nonparticipating                         
 contracts without annuity features (other than                         
 group contracts) at 12-31-58...................    $225,000            
(2) Life insurance reserves on nonparticipating                         
 contracts without annuity features (other than                         
 group contracts) at 1-1-58.....................     150,000            
                                                 ------------           
(3) Excess of item (1) over item (2) ($225,000                          
 minus $150,000)................................      75,000            
(4) 10 percent of item (3) (10% x $75,000)......                   7,500
                                                             -----------
(5) Net premiums on nonparticipating contracts                          
 without annuity features issued or renewed for                         
 5 years or more (other than group contracts)                           
 (gross premiums on such contracts ($85,000)                            
 minus return premiums ($5,000) on such                                 
 contracts).....................................      80,000            
(6) 3 percent of item (5) (3% x $80,000)........                   2,400
(7) The greater of item (4) or item (6).........                   7,500
(8) Tentative deduction under sec. 809(d)(5)                            
 (computed without regard to the limitation of                          
 sec. 809(f))...................................                   7,500
                                                             -----------
                                                                        

    (vi) See section 809(f) and Sec. 1.809-7 for limitation of the 
deduction provided by this subparagraph.
    (6) Certain accident and health insurance and group life insurance. 
(i) For taxable years beginning before January 1, 1963, an amount equal 
to two percent of the premiums for the taxable year attributable to 
group life insurance contracts, group accident and health insurance 
contracts, or group accident and health insurance contracts with a life 
feature. For taxable years beginning after December 31, 1962, the 
deduction shall be an amount equal to two percent of the premiums for 
the taxable year attributable to group life insurance contracts, 
accident and health insurance contracts (other than those to which 
section 809(d)(5) applies), or accident and health insurance contracts 
with a life feature (other than those to which section 809(d)(5) 
applies). For purposes of section 809(d)(6) and this subparagraph, the 
term ``premiums'' means the net amount of the premiums and other 
consideration attributable to such contracts taken into account under 
section 809(c)(1). The deduction allowed by section 809(d)(6) and this 
subparagraph for the taxable year and all preceding taxable years shall 
not exceed 50 percent of the net amount of the premiums attributable to 
such contracts for the taxable year. For example, assume that premiums 
attributable to group life insurance and group accident and health 
insurance contracts are $103,000 for the taxable year 1962. Assume 
further that there are $3,000 of return premiums attributable to such 
contracts for the

[[Page 538]]

taxable year. Under the provisions of section 809(d)(6) and this 
subparagraph, a deduction (determined without regard to section 809(f) 
of $2,000 (2 percent of $100,000 ($103,000-$3,000)) is allowed. Assuming 
that the company continues to receive net premiums of $100,000 
attributable to such contracts for 15 years, the cumulative amount of 
these deductions is $30,000 ($2,000 for 15 years). If, in the sixteenth 
year, net premiums attributable to such contracts amount to $60,000, no 
deduction shall be allowed under section 809(d)(6) and this subparagraph 
since the cumulative amount of these deductions ($30,000) equals 50 
percent of the current year's premiums ($60,000) from such contracts.
    (ii) In computing the deduction under section 809(d)(6), the 
determination as to when the 50 percent limitation on such deduction has 
been reached shall be based upon the amount allowed as a deduction for 
the taxable year and all preceding taxable years after the application 
of the limitation provided in section 809(f) and Sec. 1.809-7. Thus, if 
in the example set forth in paragraph (c) of Sec. 1.809-7 the 
application of the limitation provided by section 809(f) limited the 
deduction allowed for the taxable year under section 809(d)(6) to 
$3,250,000, then for purposes of determining the 50 percent limitation 
on such deduction, only $3,250,000 (the amount allowed) shall be taken 
into account.
    (iii) For purposes of determining whether the 50 percent limitation 
applies to any taxable year, the deduction provided by section 809(d)(6) 
for all preceding taxable years shall be taken into account, 
irrespective of whether or not the life insurance company claimed a 
deduction for these amounts for such preceding taxable years.
    (iv) See section 809(f) and Sec. 1.809-7 for limitation of the 
deduction provided by this subparagraph.
    (7) Assumption by another person of liabilities under insurance, 
etc., contracts. (i) The consideration (other than consideration arising 
out of reinsurance ceded as defined in paragraph (a)(1)(iii) of 
Sec. 1.809-4) in respect of the assumption by another person of 
liabilities under insurance and annuity contracts (including contracts 
supplementary thereto) of the taxpayer.
    (ii) For purposes of section 809(d)(7) and this subparagraph, the 
term assumption reinsurance means an arrangement whereby another person 
(the reinsurer) becomes solely liable to the policyholders on the 
contracts transferred by the taxpayer. Such term does not include 
indemnity reinsurance or reinsurance ceded (as defined in paragraph 
(a)(1)(iii) of Sec. 1.809-4).
    (iii) The provisions of section 809(d)(7) and this subparagraph may 
be illustrated by the following example:

    Example. During the taxable year 1958, T, a life insurance company, 
transferred a block of insurance policies and made a payment of $50,000 
to R, a life insurance company, under an arrangement whereby R became 
solely liable to the policyholders on the policies transferred by T. 
Under the provisions of section 809(d)(7) and this subparagraph, T is 
allowed a deduction of $50,000 for the taxable year 1958. For the 
treatment by R of this $50,000 payment, see section 809(c)(1) and 
paragraph (a)(1)(i) of Sec. 1.809-4. See section 806(a) and Sec. 1.806-3 
for the adjustments in reserves and assets to be made by T and R as a 
result of this transaction.

    (8) Tax-exempt interest, dividends, etc. (i) Each of the following 
items:
    (a) The life insurance company's share of interest which under 
section 103 is excluded from gross income;
     (b) The deduction for partially tax-exempt interest provided by 
section 242 (as modified by section 804(a)(3) and paragraph (d)(2)(i) of 
Sec. 1.804-2) computed with respect to the life insurance company's 
share of such interest; and
    (c) The deductions for dividends received provided by sections 243, 
244, and 245 (as modified by section 809(d)(8)(B) and subdivision (ii) 
of this subparagraph) computed with respect to the life insurance 
company's share of the dividends received.
    (ii) The modification contained in section 809(d)(8)(B) provides the 
method for applying section 246(b) (relating to limitation on aggregate 
amount of deductions for dividends received) for purposes of section 
809(d)(8)(A)(iii) and subdivision (i)(c) of this subparagraph. Under 
this method, the sum of the deductions allowed by sections 243(a)(1) 
(relating to dividends received by corporations), 244(a) (relating to 
dividends received on certain preferred stock),

[[Page 539]]

and 245 (relating to dividends received from certain foreign 
corporations) shall be limited to 85 percent of the gain from operations 
computed without regard to:
    (a) The deductions provided by section 809(d) (3), (5), and (6);
     (b) The operations loss deductions provided by section 812; and
    (c) The deductions allowed by sections 243(a)(1), 244(a), and 245.

If a life insurance company has a loss from operations (as determined 
under sec. 812) for the taxable year, the limitation provided in section 
809(d)(8)(B) and this subdivision shall not be applicable for such 
taxable year. In that event, the deductions provided by sections 
243(a)(1), 244(a), and 245 shall be allowable for all tax purposes to 
the life insurance company for such taxable year without regard to such 
limitation. If the life insurance company does not have a loss from 
operations for the taxable year, however, the limitation shall be 
applicable for all tax purposes for such taxable year. In determining 
whether a life insurance company has a loss from operations for the 
taxable year under section 812, the deductions allowed by sections 
243(a)(1), 244(a), and 245 shall be computed without regard to the 
limitation provided in section 809(d)(8)(B) and this subdivision.
    (9) Investment expenses, etc. (i) The amount of investment expenses 
to the extent not allowed as a deduction under section 804(c)(1) in 
computing investment yield. For example, if a deduction in the amount of 
$100,000 is claimed for investment expenses, which amount includes 
general expenses assigned to or included in investment expenses, and due 
to the operation of the limitation provided by section 804(c)(1) only 
$85,000 is allowed, then the excess ($15,000) shall be allowed as a 
deduction under section 809(d)(9) and this subparagraph.
    (ii) The amount (if any) by which the sum of the deductions 
allowable under section 804(c) exceeds the gross investment income. For 
example, if gross investment income under section 804(b) equals 
$400,000, and the sum of the deductions allowable under section 804(c) 
equals $425,000, then the excess ($25,000) shall be allowed as a 
deduction under section 809(d)(9) and this subparagraph.
    (iii) In determining the amount of the deductions allowed under 
subdivisions (i) and (ii) of this subparagraph, a life insurance company 
shall first take such deductions to the full extent allowable under 
section 804(c)(1), and any amount which is allowed as a deduction under 
section 804(c) shall not again be allowed as a deduction under section 
809(d)(9).
    (10) Small business deduction. The small business deduction as 
determined under section 804(a)(4).
    (11) Certain mutualization distributions. The amount of 
distributions to shareholders actually made by the life insurance 
company in 1958, 1959, 1960, and 1961 in acquisition of stock pursuant 
to a plan of mutualization adopted by the company before January 1, 
1958. If such deduction is claimed, there must be attached to the return 
of the company claiming such deduction a certified copy of the plan of 
mutualization and proof that such plan was adopted prior to January 1, 
1958. See section 809(g) and Sec. 1.809-8 for limitation of such 
deduction.
    (12) Other deductions. Except as modified by section 809(e) and 
Sec. 1.809-6, all other deductions allowed under subtitle A of the Code 
for purposes of computing taxable income to the extent not allowed as a 
deduction in computing investment yield. For example, a life insurance 
company shall be allowed a deduction under section 809(d)(12) and this 
subparagraph for amounts representing premiums charged itself with 
respect to liability for insurance and annuity benefits for its 
employees (including full-time life insurance salesmen within the 
meaning of section 7701(a)(20)) in accordance with the rules prescribed 
in sections 162 and 404 and the regulations thereunder, to the extent 
that a deduction for such amounts is not allowed under section 804(c)(1) 
and paragraph (b)(1) of Sec. 1.804-4 or section 809(d)(9) and 
subparagraph (9) of this paragraph.
    (b) Denial of double deduction. Nothing in section 809(d) shall 
permit the same item to be deducted more than once in determining gain 
or loss from operations. For example, if an item is allowed as a 
deduction for the taxable

[[Page 540]]

year by reason of its being a loss incurred within such taxable year 
(whether or not ascertained) under section 809(d)(1), such item, or any 
portion thereof, shall not also be allowed as a deduction for such 
taxable year under section 809(d)(2).

[T.D. 6535, 26 FR 527, Jan. 20, 1961, as amended by T.D. 6610, 27 FR 
8718, Aug. 31, 1962; T.D. 6886, 31 FR 8687, June 23, 1966; T.D. 6992, 34 
FR 827, Jan. 18, 1969]



Sec. 1.809-6   Modifications.

    Under section 809(e), the deductions allowed under section 
809(d)(12) and paragraph (a)(12) of Sec. 1.809-5 (relating to other 
deductions) are subject to the following modifications:
    (a) Interest. No deduction shall be allowed under section 163 for 
interest in respect of items described in section 810(c) since such 
interest is taken into account in the determination of required interest 
under section 809.
    (b) Bad debts. No deduction shall be allowed for an addition to 
reserves for bad debts under section 166(c). However, a deduction for 
specific bad debts shall be allowed to the extent that such deduction is 
allowed under section 166 and the regulations thereunder. In the case of 
a loss incurred on the sale of mortgaged or pledged property, see 
Sec. 1.166-6 of this chapter.
    (c) Charitable, etc., contributions and gifts. (1) The deduction by 
a life insurance company in any taxable year for a charitable 
contribution (as defined in section 170(c)) shall be limited to 5 
percent of the gain from operations (as determined under section 
809(b)(1)), computed without regard to any deductions for:
    (i) Charitable contributions under section 170;
    (ii) Dividends to policyholders under section 811(b);
    (iii) Certain nonparticipating contracts under section 809(d)(5);
    (iv) Group life insurance contracts and group accident and health 
insurance contracts under section 809(d)(6);
    (v) Tax-exempt interest, dividends, etc., under section 809(d)(8); 
and
    (vi) Any operations loss carryback to the taxable year under section 
812.
    (2) In applying the first sentence of section 170(b)(2) as contained 
in section 170 or, in the case of taxable years beginning after December 
31, 1969, section 170(d)(2)(B) as contained in section 170A, any excess 
of the charitable contributions made by a life insurance company in a 
taxable year over the amount deductible in such year under the 
limitation contained in subparagraph (1) of this paragraph, shall be 
reduced to the extent that such excess:
    (i) Reduces life insurance company taxable income (computed without 
regard to section 802(b)(3)) for the purpose of determining the offsets 
referred to in section 812(b)(2); and
    (ii) Increases an operations loss carryover under section 812 for a 
succeeding taxable year.
    (3) The application of the rules provided in section 809(e)(3) and 
this paragraph may be illustrated by the following example:

     Example. Assume that life insurance company P is organized on 
January 1, 1958, and has a loss from operations for that year in the 
amount of $100,000 which is an operations loss carryover to 1959. In 
1959, company P has a gain from operations and tax base (computed 
without regard to section 802(b)(3)) of $100,000 before the allowance of 
a deduction for a $5,000 charitable contribution made in 1959 and before 
the application of the operations loss carryover from 1958. Under 
section 170(b)(2), the operations loss carryover from 1958 is first 
applied to eliminate the $100,000 gain from operations and tax base in 
1959 and the $5,000 charitable contribution carryover would (except for 
the limitation contained in this paragraph) become a charitable 
contribution carryover to 1960. However, for the purpose of computing 
the offsets referred to in section 812(b)(2), the $5,000 charitable 
contribution is applied to reduce the gain from operations and tax base 
for 1959 to $95,000 before the application of the operations carryover 
from 1958. Since only $95,000 of the $100,000 loss from operations in 
1958 is an offset for 1959, the remaining $5,000 becomes an operations 
loss carryover to 1960. Accordingly, under the limitation contained in 
this paragraph, the charitable contributions carryover provided under 
the second sentence of section 170(b)(2) is eliminated.

    (d) Amortizable bond premium. No deduction shall be allowed under 
section 171 for the amortization of bond premiums since a special 
deduction for such premiums is specifically taken into account under 
section 818(b).
    (e) Net operating loss deduction. No deduction shall be allowed 
under section 172 since section 812 allows an ``operations loss 
deduction''.

[[Page 541]]

    (f) Partially tax-exempt interest. No deduction shall be allowed 
under section 242 for partially tax-exempt interest since section 
809(d)(8) allows a deduction for such interest.
    (g) Dividends received. No deduction shall be allowed under sections 
243, 244, and 245 for dividends received since section 809(d)(8) allows 
a deduction for such dividends.

[T.D. 6535, 26 FR 529, Jan. 20, 1961, as amended by T.D. 7207, 37 FR 
20797, Oct. 5, 1972]



Sec. 1.809-7   Limitation on certain deductions.

    (a) In general. Section 809(f)(1) limits the deductions under 
section 809(d) (3), (5), and (6), relating to deductions for dividends 
to policyholders, certain nonparticipating contracts, and group life, 
accident, and health insurance contracts, respectively. This limitation 
provides that the amount of such deductions shall not exceed the sum of 
(1) the amount (if any) by which the gain from operations for the 
taxable year (determined without regard to such deductions) exceeds the 
taxpayer's taxable investment income for such year, plus (2) $250,000.
    (b) Application of limitation. Section 809(f)(2) provides a priority 
system for applying the limitation contained in section 809(f)(1) and 
paragraph (a) of this section. Under this priortity system, the 
limitation shall be applied in the following order:
    (1) For taxable years beginning before January 1, 1962:
    (i) First to the amount of the deduction under section 809(d)(6) 
(relating to group life, accident, and health insurance);
    (ii) Then to the amount of the deduction under section 809(d)(5) 
(relating to certain nonparticipating contracts); and
    (iii) Finally to the amount of the deduction under section 809(d)(3) 
(relating to dividends to policyholders).
    (2) For taxable years beginning after December 31, 1961, the 
limitation shall be applied in the following order:
    (i) First to the amount of the deduction under section 809(d)(3);
    (ii) Then to the amount of the deduction under section 809(d)(6); 
and
    (iii) Finally to the amount of the deduction under section 
809(d)(5).

Thus, for taxable years beginning after December 31, 1961, the 
limitation and priority system would operate first to disallow a 
deduction under section 809(d)(5), then a deduction under section 
809(d)(6), and finally a deduction under section 809(d)(3). For purposes 
of applying the 50 percent limitation contained in section 809(d)(6) 
with respect to a taxable year beginning after December 31, 1961, the 
amount of the deductions for taxable years beginning before January 1, 
1962, shall be determined by applying the priortity system contained in 
subparagraph (1) of this paragraph.
    (c) Illustration of principles. The operation of the limitation and 
priority system provided by section 809(f) and this section may be 
illustrated by the following examples:

     Example 1. Assume the following facts with respect to M, a life 
insurance company, for the taxable year 1958:

Gain from operations computed without regard to the                     
 deductions under sec. 809(d) (3), (5), and (6).........    $100,000,000
Taxable investment income...............................      83,000,000
Tentative deduction for group life, accident, and health                
 insurance under sec. 809(d)(6).........................       4,000,000
Tentative deduction for certain nonparticipating                        
 contracts under sec. 809(d)(5).........................       6,000,000
Tentative deduction for dividends to policyholders under                
 sec. 809(d)(3).........................................      10,000,000
                                                                        

In order to determine the limitation on the deductions under section 
809(d) (3), (5), and (6), M would make up the following schedule:

                                                                                                                
                                                                                                                
                                                                                                                
(1) Statutory amount provided under sec. 809(f)(1)..................................        $250,000            
(2) Gain from                                                                                                   
 operations                                                                                                     
 computed without                                                                                               
 regard to the                                                                                                  
 deductions under                                                                                               
 sec. 809(d) (3),                                                                                               
 (5), and (6)....  $100,000,000.....................................................                            
(3) Taxable                                                                                                     
 investment                                                                                                     
 income..........  83,000,000.......................................................                            
                  -------------------------------------------------------------------                           
(4) Excess of item (2) over item (3)................................................      17,000,000            
                  --------------------------------------------------------------------                          
(5) Limitation on deductions under sec. 809(d) (3), (5), and (6) (item (1) plus item                            
 (4))...............................................................................      17,250,000            
                                                                                                                

[[Page 542]]

                                                                                                                
Since the total tentative deductions under section 809(d) (3), (5), and (6) ($20,000,000) exceeds               
 the limitation on such deductions ($17,250,000), M would make up the following schedule to                     
 determine the application of the priority system:                                                              
                                                                                                                
(6) Maximum possible deduction under sec. 809(d) (3), (5), and (6) (item (5)).......     $17,250,000            
(7) Deduction for group life, accident, and health insurance under sec. 809(d)(6)                               
 (not in excess of item (6))........................................................       4,000,000            
                  --------------------------------------------------------------------                          
(8) Maximum possible deduction under sec. 809(d)(5) (item (6) less item (7))........      13,250,000            
(9) Deduction for certain nonparticipating contracts under sec. 809(d)(5) (not in                               
 excess of item (8))................................................................       6,000,000            
                  --------------------------------------------------------------------                          
(10) Maximum possible deduction under sec. 809(d)(3) (item (8) less item (9)).......       7,250,000            
(11) Deduction for dividends to policyholders under sec. 809(d)(3) (not in excess of                            
 item (10)).........................................................................       7,250,000            
----------------------------------------------------------------------------------------------------------------

Thus, as a result of the application of the limitation and priority 
system for the taxable year 1958, M shall be allowed a deduction of 
$4,000,000 under section 809(d)(6), $6,000,000 under section 809(d)(5), 
and only $7,250,000 of the $10,000,000 tentative deduction under section 
809(d)(3).
    Example 2. The facts are the same as in example 1, except that the 
taxable year is 1962. Since the total tentative deductions under section 
809(d) (3), (5), and (6) ($20,000,000) exceeds the limitation on such 
deductions ($17,250,000), M would make up the following schedule to 
determine the application of the priority system:

(1) Maximum possible deductions under sec. 809(d) (3),                  
 (5), and (6) (item (5) in example 1).....................   $17,250,000
(2) Deduction for dividends to policyholders under sec.                 
 809(d)(3) (not in excess of item (1))....................    10,000,000
                                                           -------------
(3) Maximum possible deduction under sec. 809(d)(6) (item               
 (1) less item (2)).......................................     7,250,000
(4) Deduction for certain accident, health, and group life              
 insurance under sec. 809(d)(6) (not in excess of item                  
 (3)).....................................................     4,000,000
                                                           -------------
(5) Maximum possible deduction under sec. 809(d)(5) (item               
 (4) less item (5)).......................................     3,250,000
(6) Deduction for certain nonparticipating contracts under              
 sec. 809(d)(5) (not in excess of item (5))...............     3,250,000
                                                                        

Thus, as a result of the application of the limitation and priority 
system for the taxable year 1962, M shall be allowed a deduction of 
$10,000,000 under section 809(d)(3), $4,000,000 under section 809(d)(6), 
and only $3,250,000 of the $6,000,000 tentative deduction under section 
809(d)(5).

[T.D. 6535, 26 FR 530, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8688, June 23, 1966]



Sec. 1.809-8   Limitation on deductions for certain mutualization distributions.

    (a) Deduction not to reduce taxable investment income. Section 
809(g)(1) limits the deduction under section 809(d)(11) for certain 
mutualization distributions. This limitation provides that such 
deduction shall not exceed the amount (if any) by which the gain from 
operations for the taxable year, computed without regard to such 
deduction (but after the application of the limitation contained in 
section 809(f) and Sec. 1.809-7), exceeds the taxpayer's taxable 
investment income for such year.
    (b) Deduction not to reduce tax below that imposed by 1957 law. 
Section 809(g)(2) further limits the deduction under section 809(d)(11). 
Under section 809(g)(2), such deduction shall be allowed only to the 
extent that it (after the application of all other deductions) does not 
reduce the tax imposed by section 802(a)(1) for the taxable year below 
the amount of tax which would have been imposed for such taxable year if 
the law in effect for 1957 applied for such taxable year. If such 
deduction is claimed for 1958 (or 1959), the company shall attach to its 
return a schedule showing what its tax for 1958 (or 1959) would have 
been had such tax been computed under the law in effect for 1957.
    (c) Application of section 815. Section 809(g)(3) provides that any 
portion of a distribution which is allowed as a deduction under section 
809(d)(11) shall not be treated as a distribution to shareholders for 
purposes of section 815; except that in the case of any distributions 
made in 1959, such portion shall be treated as a distribution with

[[Page 543]]

respect to which a reduction is required under section 815(e)(2)(B) 
(relating to adjustment in allocation ratio for certain distributions 
after December 31, 1958).

[T.D. 6535, 26 FR 530, Jan. 20, 1961]



Sec. 1.809-9  Computation of the differential earnings rate and the recomputed differential earnings rate.

    (a) In general. Neither the differential earnings rate under section 
809(c) nor the recomputed differential earnings rate that is used in 
computing the recomputed differential earnings amount under section 
809(f)(3) may be less than zero.
    (b) Definitions--(1) Recomputed differential earnings amount. The 
recomputed differential earnings amount, with respect to any taxable 
year, is the amount equal to the product of--
    (i) The life insurance company's average equity base for the taxable 
year; multiplied by
    (ii) The recomputed differential earnings rate for that taxable 
year.
    (2) Recomputed differential earnings rate. The recomputed 
differential earnings rate for any taxable year equals the excess of--
    (i) The imputed earnings rate for the taxable year; over
    (ii) The average mutual earning rate for the calendar year in which 
the taxable year begins.
    (c) Effective date. The regulations are effective for all taxable 
years beginning after December 31, 1986.

[T.D. 8499, 58 FR 64899, Dec. 10, 1993]



Sec. 1.809-10  Computation of equity base.

    (a) In general. For purposes of section 809, the equity base of a 
life insurance company includes the amount of any asset valuation 
reserve and the amount of any interest maintenance reserve.
    (b) Effective date. This section is effective for taxable years 
ending after December 31, 1991.

[T.D. 8484, 58 FR 47061, Sept. 7, 1993, as amended by T.D. 8564, 59 FR 
49579, Sept. 29, 1994]



Sec. 1.810-1   Taxable years affected.

    Sections 1.810-2 through 1.810-4 are applicable only to taxable 
years beginning after December 31, 1957, and all references to sections 
of part I, subchapter L, chapter 1 of the Code are to the Internal 
Revenue Code of 1954, as amended by the Life Insurance Company Income 
Tax Act of 1959 (73 Stat. 112).

[T.D. 6535, 26 FR 531, Jan. 20, 1961]



Sec. 1.810-2   Rules for certain reserves.

    (a) Adjustment for decrease or increase in certain reserve items--
(1) Adjustment for decrease. Section 810(a) provides that if the sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the beginning of the taxable year exceeds the sum of such items at 
the end of the taxable year (reduced by the amount of investment yield 
not included in gain or loss from operations for the taxable year by 
reason of section 809(a)(1)), the amount of such excess shall be taken 
into account as a net decrease referred to in section 809(c)(2) and 
paragraph (a)(2) of Sec. 1.809-4 in determining gain or loss from 
operations.
    (2) Adjustment for increase. Section 810(b) provides that if the sum 
of the items described in section 810(c) and paragraph (b) of this 
section at the end of the taxable year (reduced by the amount of 
investment yield not included in gain or loss from operations for the 
taxable year by reason of section 809(a)(1)) exceeds the sum of such 
items at the beginning of the taxable year, the amount of such excess 
shall be taken into account as a net increase referred to in section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations.
    (b) Items taken into account. The items described in section 810(c) 
and referred to in section 810 (a) and (b) and paragraph (a) of this 
section are:
    (1) The life insurance reserves (as defined in section 801(b) and 
Sec. 1.801-4);
    (2) The unearned premiums and unpaid losses included in total 
reserves under section 801(c)(2) and Sec. 1.801-5;
    (3) The amounts (discounted at the rates of interest assumed by the 
company) necessary to satisfy the obligations under insurance or annuity 
contracts (including contracts supplementary thereto), but only if such 
obligations do not involve (at the time with respect to which the 
computation

[[Page 544]]

is made under this subparagraph) life, health, or accident 
contingencies;
    (4) Dividend accumulations, and other amounts, held at interest in 
connection with insurance or annuity contracts (including contracts 
supplementary thereto); and
    (5) Premiums received in advance, and liabilities for premium 
deposit funds.
    (6) Special contingency reserves under contracts of group term life 
insurance or group health and accident insurance which are established 
and maintained for the provision of insurance on retired lives, for 
premium stabilization, or for a combination thereof.

For purposes of this paragraph, the same item shall be counted only once 
and deficiency reserves (as defined in section 801(b)(4) and paragraph 
(e)(4) of Sec. 1.801-4) shall not be taken into account.
    (c) Special rules. For purposes of section 810 (a) and (b) and 
paragraph (a) of this section, in determining whether there is a net 
increase or decrease in the sum of the items described in section 810(c) 
and paragraph (b) of this section for the taxable year, the following 
rules shall apply:
    (1) Computation of net increase or decrease in reserves. The sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the beginning of the taxable year shall be the aggregate of the sums 
of each of such items at the beginning of the taxable year. The sum of 
the items described in section 810(c) and paragraph (b) of this section 
at the end of the taxable year shall be the aggregate of the sums of 
each of such items at the end of the taxable year. However, in order to 
determine whether there is a net increase or decrease in such items for 
the taxable year, the aggregate of the sums of the items at the end of 
the taxable year must first be reduced by the amount of investment yield 
not included in gain or loss from operations for the taxable year by 
reason of section 809(a)(1).
    (2) Effect of change in basis in computing reserves. Any increase or 
decrease in the sum of the items described in section 810(c) and 
paragraph (b) of this section for the taxable year which is attributable 
to a change in the basis used in computing such items during the taxable 
year shall not be taken into account under section 810 (a) or (b) and 
paragraph (a) of this section but shall be taken into account in the 
manner prescribed in section 810(d) and paragraph (a) of Sec. 1.810-3.
    (3) Effect of section 818(c) election. If a company which computes 
its life insurance reserves on a preliminary term basis elects to 
revalue such reserves on a net level premium basis under section 818(c), 
the sum of such reserves at the beginning and end of all taxable years 
(including the first taxable year) for which the election applies shall 
be the sum of such reserves computed on such net level premium basis.
    (4) Cross references. For taxable years beginning before January 1, 
1970, see section 810(e) (as in effect for such years) and Sec. 1.810-4 
for special rules for determining the net increase or decrease in the 
sum of the items described in section 810(c) and paragraph (b) of this 
section in the case of certain voluntary employees' beneficiary 
associations. For similar special rules in the case of life insurance 
companies issuing variable annuity contracts, see section 801(g)(4) and 
the regulations thereunder.
    (d) Illustration of principles. The provisions of section 810 (a) 
and (b) and this section may be illustrated by the following examples:

     Example 1. Assume the following facts with respect to R, a life 
insurance company:

Sum of items described in section 810(c) (1) through (6) at             
 beginning of taxable year..................................        $940
Sum of items described in section 810(c) (1) through (6) at             
 end of taxable year........................................       1,060
Required interest (as defined in section 809(a)(2)).........          70
Investment yield (as defined in section 804(c)).............         100
Amount of investment yield not included in gain or loss from            
 operations for the taxable year by reason of section                   
 809(a)(1)..................................................          70
                                                                        


[[Page 545]]

In order to determine the adjustment for decrease or increase in the sum 
of the items described in section 810(c) for the taxable year, R must 
first reduce the sum of such items at the end of the taxable year 
($1,060) by the amount of investment yield ($70) not included in gain or 
loss from operations for the taxable year by reason of section 
809(a)(1). Since the adjusted sum of such items at the end of the 
taxable year, $990 ($1,060 minus $70), exceeds the sum of such items at 
the beginning of the taxable year, $940, the excess of $50 ($990 minus 
$940) shall be taken into account as a net increase under section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations.
     Example 2. Assume the facts are the same as in example 1, except 
that the sum of the items described in section 810(c) at the beginning 
of the taxable year is $1000. Since the sum of the items described in 
section 810(c) at the beginning of taxable year, $1000, exceeds the sum 
of such items at the end of the taxable year after adjustment for the 
amount of investment yield not included in gain or loss from operations 
for the taxable year by reason of section 809(a)(1), $990 ($1060 minus 
$70), the excess of $10 ($1000 minus $990) shall be taken into account 
as a net decrease under section 809 (c)(2) and paragraph (a)(2) of 
Sec. 1.809-4 in determining gain or loss from operations.
     Example 3. Assume the following facts with respect to S, a life 
insurance company:

Sum of items described in section 810(c) (1) through (6) at             
 beginning of taxable year..................................      $1,970
Sum of items described in section 810(c) (1) through (6) at             
 the end of taxable year....................................       2,040
Required interest (as defined in section 809(a)(2)).........          60
Investment yield (as defined in section 804(c)).............          40
Amount of investment yield not included in gain or loss from            
 operations by reason of section 809(a)(1)..................          40
                                                                        

Under the provisions of section 809(a)(1), since the required interest 
($60) exceeds the investment yield ($40), the share of each and every 
item of investment yield set aside for policyholders and not included in 
gain or loss from operations for the taxable year shall be 100 percent. 
Thus, applying the provisions of section 810 (a) and (b), the sum of the 
items described in section 810(c) at the end of the taxable year 
($2,040) must first be reduced by the entire amount of the investment 
yield ($40) in order to determine the net increase or decrease in the 
sum of such items for the taxable year. Since the adjusted sum of such 
items at the end of the taxable year, $2,000 ($2,040 minus $40), is 
greater than the sum of such items at the beginning of the taxable year, 
$1,970, the excess of $30 ($2,000 minus $1,970) shall be taken into 
account as a net increase under section 809(d)(2) and paragraph (a)(2) 
of Sec. 1.809-5 in determining gain or loss from operations. No 
additional deduction is allowed under section 809(d) for the amount 
($20) by which the required interest exceeds the investment yield for 
the taxable year.
     Example 4. Assume the facts are the same as in example 1, except 
that as a result of a change in the basis used in computing an item 
described in section 810(c) during the taxable year, the sum of such 
items at the end of the taxable year is $1,200. Under the provisions of 
paragraph (c)(2) of this section, any increase or decrease in the sum of 
the section 810(c) items for the taxable year which is attributable to a 
change in the basis used in computing such items during the taxable year 
shall not be taken into account under section 810 (a) and (b). Thus, for 
purposes of section 810 (a) and (b), the sum of the items described in 
section 810(c) at the end of the taxable year shall be $1,060 (the 
amount computed without regard to the change in basis) and S shall treat 
the $50 computed in the manner described in example 1 as a net increase 
under section 809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in 
determining its gain or loss from operations for the taxable year. The 
amount of the increase in the section 810(c) items which is attributable 
to the change in basis during the taxable year, $140 ($1,200 minus 
$1,060), shall be taken into account in the manner prescribed in section 
810(d) and paragraph (a) of Sec. 1.810-3.
     Example 5. The life insurance reserves of M, a life insurance 
company, computed with respect to contracts for which such reserves are 
determined on a recognized preliminary term basis amount to $100 on 
January 1, 1960, and $110 on December 31, 1960. For the taxable year 
1960, M elects to revalue such reserves on a net level premium basis 
under section 818(c). Such reserves computed under section 818(c) amount 
to $115 on January 1, 1960, and $127 on December 31, 1960. Under the 
provisions of paragraph (c)(3) of this section, a company which makes 
the section 818(c)

[[Page 546]]

election must use the net level premium basis in computing the sum of 
its life insurance reserves at the beginning and end of all taxable 
years for which the election applies. Thus, for purposes of section 810 
(a) and (b), in determining whether there is a net increase or decrease 
in the sum of the section 810(c) items for the taxable year 1960, M 
shall include $115 as its reserves with respect to such contracts under 
section 810(c)(1) at the beginning of the taxable year and $127 as its 
reserves with respect to such contracts under section 810(c)(1) at the 
end of the taxable year.

[T.D. 6535, 26 FR 531, Jan. 20, 1961, as amended by T.D. 7163, 37 FR 
4189, Feb. 29, 1972; T.D. 7172, 37 FR 5619, Mar. 17, 1972]



Sec. 1.810-3   Adjustment for change in computing reserves.

    (a) Reserve strengthening or weakening. Section 810(d)(1) provides 
that if the basis for determining any item referred to in section 810(c) 
and paragraph (b) of Sec. 1.810-2 at the end of any taxable year differs 
from the basis for such determination at the end of the preceding 
taxable year, then so much of the difference between:
    (1) The amount of the item at the end of the taxable year, computed 
on the new basis, and
    (2) The amount of the item at the end of the taxable year, computed 
on the old basis,

as is attributable to contracts issued before the taxable year shall be 
taken into account as follows:
    (i) If the amount of the item at the end of the taxable year 
computed on the new basis exceeds the amount of the item at the end of 
the taxable year computed on the old basis, 1/10 of such excess shall be 
taken into account, for each of the succeeding 10 taxable years as a net 
increase to which section 809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 
applies; or
    (ii) If the amount of the item at the end of the taxable year 
computed on the old basis exceeds the amount of the item at the end of 
the taxable year computed on the new basis, 1/10 of such excess shall be 
taken into account, for each of the 10 succeeding taxable years, as a 
net decrease to which section 809 (c)(2) and paragraph (a)(2) of 
Sec. 1.809-4 applies.
    (b) Illustration of principles. The provisions of section 810(d)(1) 
and paragraph (a) of this section may be illustrated by the following 
examples:

     Example 1. Assume that the amount of an item described in section 
810(c) of L, a life insurance company, at the beginning of the taxable 
year 1959 is $100. Assume that at the end of the taxable year 1959, as a 
result of a change in the basis used in computing such item during the 
taxable year, the amount of the item (computed on the new basis) is $200 
but computed on the old basis would have been $150. Since the amount of 
the item at the end of the taxable year computed on the new basis, $200, 
exceeds the amount of the item at the end of the taxable year computed 
on the old basis, $150, by $50, 1/10 of the amount of such excess, or 
$5, shall be taken into account as a net increase referred to in section 
809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining gain or 
loss from operations for each of the 10 taxable years immediately 
following the taxable year 1959. Any increase (or decrease) in the sum 
of the section 810(c) items computed on the old basis at the end of the 
taxable year 1959 ($150) after adjustment for investment yield not 
included in gain or loss from operations for the taxable year by reason 
of section 809(a)(1), over the sum of such items computed on the old 
basis at the beginning of the taxable year 1959 ($100), shall be taken 
into account in the manner prescribed in section 810 (a) or (b) and 
Sec. 1.810-2 for purposes of determining L's gain or loss from 
operations for 1959.
     Example 2. Assume the facts are the same as in example 1, and that 
the sum of the items described in section 810(c) (computed on the new 
basis) is $200 on January 1, 1960, and $260 on December 31, 1960. Under 
the provisions of section 810(d)(1), as a result of the reserve 
strengthening attributable to the change in basis which occurred in 
1959, L would include $5 (computed in the manner described in example 1) 
as a net increase under section 809(d)(2) and paragraph (a)(2) of 
Sec. 1.809-5 in determining its gain or loss from operations for 1960. 
In addition to this amount, any increase (or decrease) in the sum of the 
items described in section 810(c) at the end of the taxable year 1960 
($260) after adjustment for investment yield not included in gain or 
loss from operations for the taxable year by reason of section 
809(a)(1), over the sum of such items at the beginning of the taxable 
year 1960 ($200), shall be taken into account in the manner prescribed 
in section 810 (a) or (b) and Sec. 1.810-2 for purposes of determining 
L's gain or loss from operations for 1960.

    (c) Termination as life insurance company. Section 810(d)(2) 
provides, subject to the provisions of section 381(c)(22) and the 
regulations thereunder (relating to carryovers in certain corporate

[[Page 547]]

readjustments), that if for any taxable year a company which previously 
was a life insurance company no longer meets the requirements of section 
801(a) and paragraph (b) of Sec. 1.801-3 (relating to the definition of 
a life insurance company), the balance of any adjustments remaining to 
be made under section 810(d)(1) and paragraph (a) of this section shall 
be taken into account for the preceding taxable year.
    (d) Illustration of principles. The provisions of section 810(d)(2) 
and paragraph (c) of this section may be illustrated by the following 
example:

    Example. Assume the facts are the same as in example 1 of paragraph 
(b) of this section, except that for the taxable year 1962, L no longer 
meets the requirements of section 801(a) (relating to the definition of 
a life insurance company) and that the provisions of section 381(c)(22) 
are not applicable. Under the provisions of section 810 (d)(2), the 
entire balance of the adjustment remaining to be made with respect to 
the change in basis which occurred in 1959, 8/10 of $50, or $40, shall 
be taken into account for the taxable year 1961, the last year L was a 
life insurance company. Thus, for the taxable year 1961, the total 
amount to be taken into account by L as a net increase referred to in 
section 809(d)(2) and paragraph (a)(2) of Sec. 1.809-5 in determining 
its gain or loss from operations shall be $45. Of this amount, $5 (1/10 
of $50) represents the amount determined under the provisions of section 
810(d)(1), and $40 represents the amount determined under the provisions 
of section 810(d)(2).

    (e) Effect of preliminary term election. (1) Section 810(d)(3) 
provides that if a company which computes its life insurance reserves on 
a preliminary term basis elects to revalue such reserves on a net level 
premium basis under section 818(c), such election shall not be treated 
as a change in basis within the meaning of section 810(d)(1) and 
paragraph (a) of this section. Thus, any increase or decrease in 
reserves attributable to such election shall not be taken into account 
under section 810(d)(1) and paragraph (a) of this section but shall be 
taken into account in the manner prescribed in section 810 (a) and (b) 
and paragraph (a) of Sec. 1.810-2. See paragraph (c)(3) of Sec. 1.810-2.
    (2) Section 810(d)(3) further provides that where an election under 
section 818(c) would apply to an item referred to in section 810(c) but 
for the fact that the basis used in computing such item has actually 
been changed, any increase or decrease in such item attributable to such 
actual change in basis shall be subject to the adjustment required under 
section 810(d)(1) and paragraph (a) of this section. In such a case, 
however, for purposes of section 810(d)(1)(B) and paragraph (a)(2) of 
this section, the amount of such item at the end of the taxable year 
computed on the old basis shall be the amount of such item at the end of 
the taxable year computed as if the election under section 818(c) 
applied in respect of such item for the taxable year.
    (f) Illustration of principles. The provisions of section 810(d)(3) 
and par- agraph (e) of this section may be illustrated by the following 
examples:

    Example 1. Assume that S, a life insurance company which computes 
its life insurance reserves on a 3-percent assumed rate and the 
Commissioner's reserve valuation method (one of the recognized 
preliminary term reserve methods), elects to revalue such reserves on a 
net level premium method under section 818(c) and that the significant 
facts are as follows:

------------------------------------------------------------------------
                                                                   Dec. 
                                                        Jan. 1,    31,  
                                                          1958     1958 
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                                
 Commissioner's reserve valuation method..............      100      118
Reserves at 3-percent assumed rate, after restatement                   
 under section 818(c).................................      110      131
------------------------------------------------------------------------

Under the provisions of section 810(d)(3), an election under section 
818(c) is not treated as a change in basis for purposes of section 
810(d)(1). Accordingly, the increase of $21 ($131 minus $110) 
attributable to such election shall not be subject to the adjustment 
provided by section 810(d)(1) but shall be taken into account in the 
manner prescribed in section 810(b). For purposes of determining the 
amount to be taken into account under section 810(b), the reserves with 
respect to the contracts subject to the section 818(c) election shall be 
$110 at the beginning of the taxable year 1958 and $131 at the end of 
the taxable year 1958. However, as a result of making the election under 
section 818(c), the difference ($10) between the reserves computed on 
the preliminary term basis on January 1, 1958 ($100) and the reserves 
restated on the net level premium basis on January 1, 1958 ($110) shall 
not be taken into account under section 809(d) for the year 1958, or for 
any subsequent taxable year.
    Example 2. Assume the facts are the same as in example 1, except 
that during the taxable year 1959, S actually changed from the

[[Page 548]]

preliminary term basis to a net level premium basis which was identical 
with the net level premium basis used under the section 818(c) election 
and that the significant facts are as follows:

------------------------------------------------------------------------
                                                                   Dec. 
                                                        Jan. 1,    31,  
                                                          1959     1959 
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                                
 Commissioner's reserve valuation method..............      118      127
Reserves at 3-percent assumed rate, after restatement                   
 under section 818(c).................................      131      142
Strengthened reserves at 3-percent assumed rate and                     
 net level premium method.............................  .......      142
------------------------------------------------------------------------

Under the provisions of section 810(d)(3), if a company which has made 
an election under section 818(c) which has not been revoked actually 
changes the basis used by it in computing the reserves subject to such 
election, any increase or decrease in reserves attributable to such 
change in basis shall be taken into account in the manner prescribed in 
section 810(d)(1). Since S actually changed to the same basis which it 
used in computing its reserves under section 818(c), the reserves at the 
end of the taxable year computed on the new basis ($142) are the same as 
the reserves at the end of the taxable year computed on the old basis 
($142), i.e., the basis which would have applied under section 818(c) if 
the election applied for 1959. Accordingly, no adjustment under section 
810(d)(1) is required.
    Example 3. Assume the facts are the same as in example 1, except 
that during the taxable year 1960, S actually changed the basis used by 
it in computing its reserves on a certain block of contracts subject to 
the election under section 818(c) and that the significant facts with 
respect to this block of contracts are as follows:

------------------------------------------------------------------------
                                                                   Dec. 
                                                        Jan. 1,    31,  
                                                          1960     1960 
------------------------------------------------------------------------
Book reserves at 3-percent assumed rate,                                
 Commissioner's reserve valuation method..............       50       63
Reserves at 3-percent assumed rate, after restatement                   
 under section 818(c).................................       60       75
Strengthened reserves at 2-percent assumed rate and                     
 net level premium method.............................  .......       95
------------------------------------------------------------------------

Under the provisions of section 810(d)(3), the amount of the reserves 
subject to the section 818(c) election at the end of the taxable year 
computed on the old basis shall be the amount of such reserves at the 
end of the taxable year determined under section 818(c) ($75). Since the 
reserves at the end of the taxable year computed on the new basis, $95, 
exceed the reserves at the end of the taxable year computed on the old 
basis, $75, by $20, 1/10 of the excess of $20, or $2, shall be taken 
into account as a net increase referred to in section 809(d)(2) and 
paragraph (a)(2) of Sec. 1.809-5 in determining gain or loss from 
operations for each of the 10 taxable years immediately following the 
taxable year 1960. For purposes of determining whether there is a net 
increase or decrease in the sum of the items described in section 810(c) 
for the taxable year 1960 under section 810 (a) or (b), the sum of the 
reserves with respect to such block of contracts shall be $60 at the 
beginning of the taxable year and $75 at the end of the taxable year 
(the amount of such reserves computed under section 818(c) at the 
beginning and end of the taxable year). The difference ($10) between the 
reserves computed on the preliminary term basis on January 1, 1960 ($50) 
and the reserves restated on the net level premium basis on January 1, 
1960 ($60) shall not be taken into account under section 809(d) for the 
year 1960, or for any subsequent taxable year.

[T.D. 6535, 26 FR 532, Jan. 20, 1961]



Sec. 1.810-4   Certain decreases in reserves of voluntary employees' beneficiary associations.

    (a) Decreases due to voluntary lapses of policies issued before 
January 1, 1958. (1) Section 810(e) provides that if for any taxable 
year a life insurance company which meets the requirements of section 
501(c)(9), other than the requirement of subparagraph (B) thereof, makes 
an election in the manner provided in section 810(e)(3) and paragraph 
(b) of this section, only 11\1/2\ percent of any decrease in life 
insurance reserves (as defined in section 801(b) and Sec. 1.801-4) 
attributable to the voluntary lapse on or after January 1, 1958, of any 
policy issued prior to that date shall be taken into account under 
section 810 (a) or (b) and paragraph (a) of Sec. 1.810-2 in determining 
the net increase or decrease in the sum of the items described in 
section 810(c) during the taxable year. In applying the preceding 
sentence, the decrease in the reserve for any policy shall be determined 
by reference to the amount of such reserve at the beginning of the 
taxable year,

[[Page 549]]

reduced by any amount allowable as a deduction under section 809(d)(1) 
and paragraph (a)(1) of Sec. 1.809-5 in respect of such policy by reason 
of such lapse. The election under section 810(e) shall be adhered to in 
computing the company's gain or loss from operation for the taxable year 
for which the election is made and for all subsequent taxable years, 
unless consent to revoke such election is obtained from the 
Commissioner.
    (2) The application of the election provided under section 810(e) 
and subparagraph (1) of this paragraph may be illustrated by the 
following example:

    Example. For the taxable year 1960, M, a life insurance company 
which meets the requirements of section 501(c)(9), other than the 
requirement of subparagraph (B) thereof, makes the election under 
section 810(e). Assume the following facts with respect to a policy 
issued in 1955 which voluntarily lapsed during the taxable year:

(1) Life insurance reserve on January 1, 1960................       $600
(2) Amount allowable as a deduction under sec. 809(d)(1).....        200
(3) Decrease in life insurance reserves for sec. 810(e)                 
 purposes (item (1) minus item (2))..........................        400
(4) Amount taken into account under sec. 810 (a) and (b) by             
 reason of sec. 810(e) election (11 1/2% x $400).............         46
                                                                        

Under the provisions of section 810(e) and subparagraph (1) of this 
paragraph, M would include $46 as its life insurance reserve with 
respect to such policy under section 810(c)(1) at the beginning of the 
taxable year 1960 for purposes of determining the net increase or 
decrease in the sum of the items described in section 810(c) for the 
taxable year under section 810 (a) or (b).

    (b) Time and manner of making election. The election provided by 
section 810(e)(3) shall be made in a statement attached to the life 
insurance company's income tax return for the first taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. However, if the last day prescribed by law (including extensions 
thereof) for filing a return for the first taxable year for which the 
company desires the election to apply falls before January 20, 1961, the 
election provided by section 810(e)(3) may be made for such year by 
filing the statement and an amended return for such taxable year (and 
all subsequent taxable years for which returns have been filed) before 
April 21, 1961. The statement shall indicate that the company meets the 
requirements of section 501(c)(9), other than the requirement of 
subparagraph (B) thereof, and has made the election provided under 
section 810(e) and paragraph (a) of this section. The statement shall 
set forth the following information with respect to each policy 
described in paragraph (a) of this section which has voluntarily lapsed 
during such year:
    (1) Type of policy.
    (2) Date issued.
    (3) Date lapsed.
    (4) Reason for lapse.
    (5) Policy reserve as of beginning of taxable year.
    (6) Deduction allowable under section 809(d)(1) and paragraph (a)(1) 
of Sec. 1.809-5 during taxable year by reason of lapse.
    (7) Decrease in policy reserve for section 810(e) purposes (excess 
of (5) over (6)).

In addition, the statement shall set forth the total of the amounts 
referred to in subparagraph (7) of this paragraph with respect to all 
policies described in paragraph (a) of this section which have 
voluntarily lapsed during the taxable year.
    (c) Scope of election. An election made under section 810(e)(3) and 
paragraph (a) of this section shall be effective for the taxable year 
for which made and for all succeeding taxable years, unless consent to 
revoke the election is obtained from the Commissioner. However, for 
taxable years beginning prior to January 20, 1961, a company may revoke 
the election provided by section 810(e)(3) without obtaining consent 
from the Commissioner by filing, before April 21, 1961, a statement that 
the company desires to revoke such election. An amended return 
reflecting such revocation must accompany the statement for all taxable 
years for which returns have been filed with respect to such election.
    (d) Disallowance of carryovers from pre-1958 losses from operations. 
For any taxable year for which the election provided under section 
810(e)(3) and paragraph (b) of this section is effective, the provisions 
of section 812(b)(1) and Sec. 1.812-4 shall not apply with respect to

[[Page 550]]

any loss from operations for any taxable year beginning before January 
1, 1958.
    (e) Effective date; cross reference. The provisions of section 
810(e) (as in effect for such years) and this section apply only with 
respect to taxable years beginning before January 1, 1970. For 
provisions relating to certain funded pension trusts applicable to 
taxable years beginning after December 31, 1969, see section 501(c)(18) 
and the regulations thereunder.

[T.D. 6535, 26 FR 533, Jan. 20, 1961, as amended by T.D. 7172, 37 FR 
5619, Mar. 17, 1972]



Sec. 1.811-1   Taxable years affected.

    Section 1.811-2, except as otherwise provided therein, is applicable 
only to taxable years beginning after December 31, 1957, and all 
references to sections of part I, subchapter L, chapter 1 of the Code 
are to the Internal Revenue Code of 1954, as amended by the Life 
Insurance Company Income Tax Act of 1959 (73 Stat. 112).

[T.D. 6535, 26 FR 534, Jan. 20, 1961]



Sec. 1.811-2   Dividends to policyholders.

    (a) Dividends to policyholders defined. Section 811(a) defines the 
term dividends to policyholders, for purposes of part I, subchapter L, 
chapter 1 of the Code, to mean dividends and similar distributions to 
policyholders in their capacity as such. The term includes amounts 
returned to policyholders where the amount is not fixed in the contract 
but depends on the experience of the company or the discretion of the 
management. In general, any payment not fixed in the contract which is 
made with respect to a participating contract (that is, a contract which 
during the taxable year contains a right to participate in the divisible 
surplus of the company) shall be treated as a dividend to policyholders. 
Similarly, any amount refunded or allowed as a rate credit with respect 
to either a participating or a nonparticipating contract shall be 
treated as a dividend to policyholders if such amount depends on the 
experience of the company. However, the term does not include interest 
paid (as defined in section 805(e) and paragraph (b) of Sec. 1.805-8) or 
return premiums (as defined in section 809(c) and paragraph (a)(1)(ii) 
of Sec. 1.809-4). Thus, so-called excess-interest dividends and amounts 
returned by one life insurance company to another in respect of 
reinsurance ceded shall not be treated as dividends to policyholders 
even though such amounts are not fixed in the contract but depend upon 
the experience of the company or the discretion of the management.
    (b) Amount of deduction--(1) In general. Section 811(b)(1) provides, 
subject to the limitation of section 809(f), that the deduction for 
dividends to policyholders for any taxable year shall be an amount equal 
to the dividends to policyholders paid during the taxable year:
    (i) Increased by the excess of the amounts held as reserves for 
dividends to policyholders at the end of the taxable year for payment 
during the year following the taxable year, over the amounts held as 
reserves for dividends to policyholders at the end of the preceding 
taxable year for payment during the taxable year, or
    (ii) Decreased by the excess of the amounts held as reserves for 
dividends to policyholders at the end of the preceding taxable year for 
payment during the taxable year, over the amounts held as reserves for 
dividends to policyholders at the end of the taxable year for payment 
during the year following the taxable year.

For the rule as to when dividends are considered paid, see section 561 
and the regulations thereunder. For the determination of the amounts 
held as reserves for dividends to policyholders, see paragraph (c) of 
this section. For special provisions relating to the treatment of 
dividends to policyholders paid with respect to policies reinsured under 
modified coinsurance contracts, see section 820(c)(5) and the 
regulations thereunder.
    (2) Certain amounts to be treated as net decreases. Section 
811(b)(2) provides that if the amount determined under subparagraph 
(1)(ii) of this paragraph exceeds the dividends to policyholders paid 
during the taxable year, the amount of such excess shall be a net 
decrease referred to in section 809(c)(2).
    (c) Reserves for dividends to policyholders defined--(1) In general. 
The term reserves for dividends to policyholders, as

[[Page 551]]

used in section 811(b)(1) (A) and (B) and paragraph (b)(1) of this 
section, means only those amounts:
    (i) Actually held, or set aside as provided in subparagraph (2) of 
this paragraph and thus treated as actually held, by the company at the 
end of the taxable year, and
    (ii) With respect to which, at the end of the taxable year or, if 
set aside, within the period prescribed in subparagraph (2) of this 
paragraph, the company is under an obligation, which is either fixed or 
determined according to a formula which is fixed and not subject to 
change by the company, to pay such amounts as dividends to policyholders 
(as defined in section 811(a) and paragraph (a) of this section) during 
the year following the taxable year.
    (2) Amounts set aside. (i) In the case of a life insurance company 
(as defined in section 801(a) and paragraph (b) of Sec. 1.801-3), all 
amounts set aside before the 16th day of the 3d month of the year 
following the taxable year for payment as dividends to policyholders (as 
defined in section 811(a) and paragraph (a) of this section) during the 
year following such taxable year shall be treated as amounts actually 
held at the end of the taxable year.
    (ii) In the case of a mutual savings bank subject to the tax imposed 
by section 594, all amounts set aside before the 16th day of the 4th 
month of the year following the taxable year for payment as dividends to 
policyholders (as defined in section 811(a) and paragraph (a) of this 
section) during the year following such taxable year shall be treated as 
amounts actually held at the end of the taxable year.
    (3) 1958 reserve for dividends to policyholders. For purposes of 
section 811(b) and paragraph (b) of this section, the amounts held at 
the end of 1957 as reserves for dividends to policyholders payable 
during 1958 shall be determined as if part I, subchapter L, chapter 1 of 
the Code (as in effect for 1958) applied for 1957. Any adjustment in the 
reserves for dividends to policyholders at the beginning of 1957 
required as a result of an understatement or overstatement of such 
reserves by the company shall be made to the balance of such reserves as 
of the beginning of 1957. For example, if at the beginning of 1957 the 
reserves for dividends to policyholders are stated to be $100 and it is 
subsequently determined that such reserves should have been $90, the 
reserves at the beginning of 1957 shall be reduced by $10. Under no 
circumstances shall an adjustment required with regard to the beginning 
1957 reserves be made to the reserves at the end of 1957.
    (4) Information to be filed. Every company claiming a deduction for 
dividends to policyholders shall keep such permanent records as are 
necessary to establish the amount of dividends actually paid during the 
taxable year. Such company shall also keep a copy of the dividend 
resolution and any necessary supporting data relating to the amounts of 
dividends declared and to the amounts held or set aside as reserves for 
dividends to policyholders during the taxable year. The company shall 
file with its return a concise statement of the pertinent facts relating 
to its dividend policy for the year, the amount of dividends actually 
paid during the taxable year, and the amounts held or set aside as 
reserves for dividends to policyholders during the taxable year.
    (d) Illustration of principles. The provisions of section 811(b) and 
this section may be illustrated by the following examples:

    Example 1. On December 31, 1959, M, a life insurance company, held 
$200 as reserves for dividends to policyholders due and payable in 1960. 
On March 10, 1960, M set aside an additional $50 as reserves for 
dividends to policyholders due and payable in 1960. During the taxable 
year 1960, M paid $240 as dividends to its policyholders and at the end 
of the taxable year 1960, held $175 as reserves for dividends to 
policyholders due and payable in 1961. No additional amount was set 
aside before March 16, 1961, as reserves for dividends to policyholders 
due and payable in 1961. For the taxable year 1960, subject to the 
limitation of section 809(f), M's deduction for dividends to 
policyholders is $165, computed as follows:

(1) Dividends paid to policyholders during the taxable                  
 year 1960..............................................            $240
(2) Decreased by the excess of item (a) over item (b):                  
(a) Reserves for dividends to policyholders as of 12-31-                
 59 (including amounts set aside as provided in                         
 paragraph (c)(2) of this section)......................    $250        
(b) Reserves for dividends to policyholders as of 12-31-                
 60-....................................................     175        

[[Page 552]]

                                                                        
                                                           -----      75
                                                                 -------
(3) Deduction for dividends to policyholders under sec.                 
 811(b) (computed without regard to the limitation of                   
 sec. 809(f))...........................................            $165
                                                                        

    Example 2. On December 31, 1960, S, a life insurance company, held 
$100 as reserves for dividends to policyholders due and payable in 1961. 
During the taxable year 1961, S paid $125 as dividends to its 
policyholders and at the end of the taxable year 1961, held $110 as 
reserves for dividends to policyholders due and payable in 1962. No 
additional amount was set aside for dividends to policyholders as 
provided in paragraph (c)(2) of this section before March 16, 1961, or 
March 16, 1962. For the taxable year 1961, subject to the limitation of 
section 809(f), S's deduction for dividends to policyholders is $135, 
computed as follows:

(1) Dividends paid to policyholders during the taxable                  
 year 1961..............................................            $125
(2) Increased by the excess of item (a) over item (b):                  
(a) Reserves for dividends to policyholders as of 12-31-                
 61.....................................................    $110        
(b) Reserves for dividends to policyholders as of 12-31-                
 60.....................................................     100        
                                                           -----      10
                                                                 -------
(3) Deduction for dividends to policyholders under sec.                 
 811(b) (computed without regard to the limitation of                   
 sec. 809(f))...........................................            $135
                                                                        

    Example 3. Assume the facts are the same as in example 2, except 
that on December 31, 1960, the amount held as reserves for dividends to 
policyholders due and payable in 1961 is $250. For the taxable year 
1961, S's deduction for dividends to policyholders is zero, computed as 
follows:

(1) Dividends paid to policyholders during the taxable                  
 year 1961..............................................            $125
(2) Decreased by the excess of item (a) over item (b):                  
(a) Reserves for dividends to policyholders as of 12-31-                
 60.....................................................    $250        
(b) Reserves for dividends to policyholders as of 12-31-                
 61.....................................................     110        
                                                           -----     140
                                                                 -------
(3) Deduction for dividends to policyholders under sec.                 
 811(b) (computed without regard to the limitation of                   
 sec. 809(f))...........................................              $0
                                                                        

Under the provisions of section 811(b)(2) and paragraph (b)(2) of this 
section, since the decrease in the reserves for dividends to 
policyholders during the taxable year, $140 ($250 minus $110), exceeds 
the dividends to policyholders paid during the taxable year 1961, $125, 
S shall include $15 (the amount of such excess) as a net decrease under 
section 809(c)(2) and paragraph (a)(2) of Sec. 1.809-4 in determining 
its gain or loss from operations for 1961.

[T.D. 6535, 26 FR 534, Jan. 20, 1961]



Sec. 1.812-1   Taxable years affected.

    Sections 1.812-2 through 1.812-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112) and the Act of October 23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]



Sec. 1.812-2   Operations loss deduction.

    (a) Allowance of deduction. Section 812 provides that a life 
insurance company shall be allowed a deduction in computing gain or loss 
from operations for any taxable year beginning after December 31, 1957, 
in an amount equal to the aggregate of the operations loss carryovers 
and operations loss carrybacks to such taxable year. This deduction is 
referred to as the operations loss deduction. The loss from operations 
(computed under section 809), is the basis for the computation of the 
operations loss carryovers and operations loss carrybacks and ultimately 
for the operations loss deduction itself. Section 809(e)(5) provides 
that the net operating loss deduction provided in section 172 shall not 
be allowed a life insurance company since the operations loss deduction 
provided in section 812 and this paragraph shall be allowed in lieu 
thereof.
    (b) Steps in computation of operations loss deduction. The three 
steps to be taken in the ascertainment of the operations loss deduction 
for any taxable year beginning after December 31, 1957, are as follows:
    (1) Compute the loss from operations for any preceding or succeeding 
taxable year from which a loss from operations may be carried over or 
carried back to such taxable year.
    (2) Compute the operations loss carryovers to such taxable year from 
such preceding taxable years and the operations loss carrybacks to such 
taxable year from such succeeding taxable years.
    (3) Add such operations loss carryovers and carrybacks in order to

[[Page 553]]

determine the operations loss deduction for such taxable year.
    (c) Statement with tax return. Every life insurance company claiming 
an operations loss deduction for any taxable year shall file with its 
return for such year a concise statement setting forth the amount of the 
operations loss deduction claimed and all material and pertinent facts 
relative thereto, including a detailed schedule showing the computation 
of the operations loss deduction.
    (d) Ascertainment of deduction dependent upon operations loss 
carryback. If a life insurance company is entitled in computing its 
operations loss deduction to a carryback which it is not able to 
ascertain at the time its return is due, it shall compute the operations 
loss deduction on its return without regard to such operations loss 
carryback. When the life insurance company ascertains the operations 
loss carryback, it may within the applicable period of limitations file 
a claim for credit or refund of the overpayment, if any, resulting from 
the failure to compute the operations loss deduction for the taxable 
year with the inclusion of such carryback; or it may file an application 
under the provisions of section 6411 for a tentative carryback 
adjustment.
    (e) Law applicable to computations. The following rules shall apply 
to all taxable years beginning after December 31, 1957:
    (1) In determining the amount of any operations loss carryback or 
carryover to any taxable year, the necessary computations involving any 
other taxable year shall be made under the law applicable to such other 
taxable year.
    (2) The loss from operations for any taxable year shall be 
determined under the law applicable to that year without regard to the 
year to which it is to be carried and in which, in effect, it is to be 
deducted as part of the operations loss deduction.
    (3) The amount of the operations loss deduction which shall be 
allowed for any taxable year shall be determined under the law 
applicable for that year.
    (f) Special rules. For purposes of taxable years beginning after 
December 31, 1954, and before January 1, 1958:
    (1) The amount of any:
    (i) Loss from operations;
    (ii) Operations loss carryback; and
    (iii) Operations loss carryover

shall be computed as if part I, subchapter L, chapter 1 of the Code (as 
in effect for 1958) and section 381(c)(22) applied to such taxable 
years.
    (2) A loss from operations (determined in accordance with the 
provisions of section 812(b)(1)(C) and this paragraph) for such taxable 
years shall in no way affect the tax liability of any life insurance 
company for such taxable years. However, such loss may, to the extent 
allowed as an operations loss carryover under section 812, affect the 
tax liability of a life insurance company for a taxable year beginning 
after December 31, 1957. For example, for the taxable year 1956, X, a 
life insurance company, has a loss from operations (determined in 
accordance with the provisions of section 812(b)(1)(C) and this 
paragraph). Such loss shall in no way affect X's tax liability for the 
taxable years 1956 (the year of the loss), 1955 (a year to which such 
loss shall be carried back), or 1957 (a year to which such loss shall be 
carried forward). However, to the extent allowed under section 812, any 
amount of the loss for 1956 remaining after such carryback and 
carryforward shall be taken into account in determining X's tax 
liability for taxable years beginning after December 31, 1957.

[T.D. 6535, 26 FR 536, Jan. 20, 1961]



Sec. 1.812-3   Computation of loss from operations.

    (a) Modification of deductions. A loss from operations is sustained 
by a life insurance company in any taxable year, if and to the extent 
that, for such year, there is an excess of the sum of the deductions 
provided by section 809(d) over the sum of (1) the life insurance 
company's share of each and every item of investment yield (including 
tax-exempt interest, partially tax-exempt interest, and dividends 
received) as determined under section 809(b)(3), and (2) the sum of the 
items of gross amount taken into account under section 809(c). In 
determining the loss from operations for purposes of section 812:

[[Page 554]]

    (i) No deduction shall be allowed under section 812 for the 
operations loss deduction.
    (ii) The 85 percent limitation on dividends received provided by 
section 246 (b) as modified by section 809(d)(8)(B) shall not apply to 
the deductions otherwise allowed under:
    (a) Section 243(a) in respect to dividends received by corporations,
    (b) Section 244 in respect of dividends received on certain 
preferred stock of public utilities, and
    (c) Section 245 in respect of dividends received from certain 
foreign corporations.
    (b) Illustration of principles. The application of paragraph (a) of 
this section may be illustrated by the following example:

    Example. For the taxable year 1960, X, a life insurance company, has 
items taken into account under section 809(c) amounting to $150,000, its 
share of the investment yield amounts to $250,000, and total deductions 
allowed by section 809(d) of $375,000, exclusive of any operations loss 
deduction and exclusive of any deduction for dividends received. In 
1960, X received as its share of dividends entitled to the benefits of 
section 243(a) the amount of $100,000. These dividends are included in 
X's share of the investment yield. X has no other deductions to which 
section 812(c) applies. On the basis of these facts, X has a loss from 
operations for the taxable year 1960 of $60,000, computed as follows:

Deductions for 1960.........................................    $375,000
Plus: Deduction for dividends received computed without                 
 regard to the limitation provided by sec. 246(b), as                   
 modified by sec. 809(d)(8)(B) (85% of $100,000)............      85,000
                                                             -----------
    Total deductions as modified by sec. 812(c).............     460,000
Less: Sum of sec. 809(c) items and X's share of investment              
 yield (including $100,000 of dividends)....................     400,000
                                                             -----------
    Loss from operations for 1960...........................    (60,000)
                                                                        

[T.D. 6535, 26 FR 536, Jan. 20, 1961]



Sec. 1.812-4   Operations loss carrybacks and operations loss carryovers.

    (a) In general--(1) Years to which loss may be carried. In order to 
compute the operations loss deduction of a life insurance company the 
company must first determine the part of any losses from operations for 
any preceding or succeeding taxable years which are carryovers or 
carrybacks to the taxable year in issue. Except as otherwise provided by 
this paragraph, a loss from operations for taxable years beginning after 
December 31, 1954, shall be carried back to each of the 3 taxable years 
preceding the loss year and shall be carried forward to each of the 5 
taxable years succeeding the loss year. Except as limited by section 
812(e)(2) and paragraph (b) of Sec. 1.812-6, if the life insurance 
company is a new company (as defined in section 812(e)(1)) for the loss 
year, the loss from operations shall be carried back to each of the 3 
taxable years preceding the loss year and shall be carried forward to 
each of the 8 taxable years succeeding the loss year. In determining the 
span of years for which a loss from operations may be carried, taxable 
years in which a company does not qualify as a life insurance company 
(as defined in section 801(a)), or is not treated as a new company, 
shall be taken into account.
    (2) Special transitional rules. (i) A loss from operations for any 
taxable year beginning before January 1, 1958, shall not be carried back 
to any taxable year beginning before January 1, 1955. Furthermore, a 
loss from operations for any taxable year beginning after December 31, 
1957, shall not be carried back to any taxable year beginning before 
January 1, 1958.
    (ii) If for any taxable year a life insurance company has made an 
election under section 810(e) (relating to certain decreases in reserves 
for voluntary employees' beneficiary associations) which is effective 
for such taxable year, the provisions of section 812(b)(1) and 
subparagraph (1) of this paragraph shall not apply with respect to any 
loss from operations for any taxable year beginning before January 1, 
1958.
    (3) Illustration of principles. The provisions of section 812(b)(1) 
and of this paragraph may be illustrated by the following examples:

    Example 1. P, a life insurance company, organized in 1940, has a 
loss from operations of $1,000 in 1958. This loss cannot be carried 
back, but shall be carried forward to each of the 5 taxable years 
following 1958.
    Example 2. Q, a life insurance company, organized in 1940, has a 
loss from operations of $1,200 in 1959. This loss shall be carried back 
to the taxable year 1958 and then shall be carried forward to each of 
the 5 taxable years following 1959.

[[Page 555]]

    Example 3. R, a life insurance company, organized in 1940, has a 
loss from operations of $1,300 for the taxable year 1956. This loss 
shall first be carried back to the taxable year 1955 and then shall be 
carried forward to each of the 5 taxable years following 1956. The loss 
for 1956, carryback to 1955, and carryover to 1957 shall each be 
computed as if part I, subchapter L, chapter 1 of the Code (as in effect 
for 1958) applied to such taxable years.
    Example 4. S, a life insurance company, organized in 1958 and 
meeting the provisions of section 812(e) (rules relating to new 
companies), has a loss from operations of $1,400 for the taxable year 
1958. This loss cannot be carried back, but shall be carried forward to 
each of the 8 taxable years following 1958, provided, however, S is not 
a nonqualified corporation at any time during the loss year (1958) or 
any taxable year thereafter.
    Example 5. T, a life insurance company, organized in 1954 and 
meeting the provisions of section 812(e) (rules relating to new 
companies), has a loss from operations of $1,500 for the taxable year 
1956. This loss shall first be carried back to the taxable year 1955 and 
then carried forward to each of the 8 taxable years following 1956, 
provided, however, T is not a nonqualified corporation at any time 
during the loss year (1956) or any taxable year thereafter. The loss for 
1956, carryback to 1955, and carryover to 1957 shall each be computed as 
if part I of subchapter L (as in effect for 1958) applied to such 
taxable years.

    (4) Periods of less than 12 months. A fractional part of a year 
which is a taxable year under sections 441(b) and 7701(a)(23) is a 
preceding or a succeeding taxable year for the purpose of determining 
under section 812 the first, second, etc., preceding or succeeding 
taxable year. For the determination of the loss from operations for 
periods of less than 12 months, see section 818(d) and the regulations 
thereunder.
    (5) Amount of loss to be carried. The amount which is carried back 
or carried over to any taxable year is the loss from operations to the 
extent it was not absorbed in the computation of gain from operations 
for other taxable years, preceding such taxable year, to which it may be 
carried back or carried over. For the purpose of determining the gain 
from operations for any such preceding taxable year, the various 
operations loss carryovers and carrybacks to such taxable year are 
considered to be applied in reduction of the gain from operations in the 
order of the taxable years from which such losses are carried over or 
carried back, beginning with the loss for the earliest taxable year.
    (6) Corporate acquisitions. For the computation of the operations 
loss carryovers in the case of certain acquisitions of the assets of a 
life insurance company by another life insurance company, see section 
381(c)(22) and the regulations thereunder.
    (b) Portion of loss from operations which is a carryback or a 
carryover to the taxable year in issue--(1) Manner of computation. (i) A 
loss from operations shall first be carried back to the earliest taxable 
year permissible under section 812(b) and paragraph (a) of this section 
for which such loss is allowable as a carryback or a carryover. The 
entire amount of the loss from operation shall be carried back to such 
earliest year.
    (ii) Section 812(b)(2) provides that the portion of the loss from 
operations which shall be carried to each of the taxable years 
subsequent to the earliest taxable year shall be the excess (if any) of 
the amount of the loss from operations over the sum of the offsets (as 
defined in section 812(d) and paragraph (a) of Sec. 1.812-5) for all 
prior taxable years to which the loss from operations may be carried.
    (2) Illustration of principles. The application of this paragraph 
may be illustrated by the following example:

    Example. T, a life insurance company (which is not a new company as 
defined in section 812(e)(1)), has a loss from operations for 1960. The 
entire amount of the loss from operations for 1960 shall first be 
carried back to 1958. The amount of the carryback to 1959 is the excess 
(if any) of the 1960 loss over the offset for 1958. The amount of the 
carryover to 1961 is the excess (if any) of the 1960 loss over the sum 
of the offsets for 1958 and 1959. The amount of the 1960 loss remaining 
(if any) to be carried over to 1962, 1963, or 1964 shall be computed in 
a like manner.

[T.D. 6535, 26 FR 537, Jan. 20, 1961]



Sec. 1.812-5   Offset.

    (a) Offset defined. Section 812(d) defines the term ``offset'' for 
purposes of section 812(b)(2) and paragraph (b)(1)(ii) of Sec. 1.812-4. 
For any taxable year the offset is only that portion of the increase in 
the operations loss deduction for the taxable year which is necessary to 
reduce the life insurance company

[[Page 556]]

taxable income (computed without regard to section 802(b)(3)) for such 
year to zero. For purposes of the preceding sentence, the offset shall 
be determined with the modifications prescribed in paragraph (b) of this 
section. Such modifications shall be made independently of, and without 
reference to, the modifications required by paragraph (a) of Sec. 1.812-
3 for purposes of computing the loss from operations itself.
    (b) Modifications--(1) Operations loss deduction--(i) In general. 
Section 812(d)(2) provides that for purposes of section 812(d)(1) 
(relating to the definition of offset), the operations loss deduction 
for any taxable year shall be computed by taking into account only such 
losses from operations otherwise allowable as carryovers or as 
carrybacks to such taxable year as were sustained in taxable years 
preceding the taxable year in which the life insurance company sustained 
the loss from operations from which the offset is to be deducted. Thus, 
for such purposes the loss from operations for the loss year or for any 
taxable year thereafter shall not be taken into account.
    (ii) Illustration of principles. The provisions of this subparagraph 
may be illustrated by the following example:

    Example. In computing the operations loss deduction for 1960, Y, a 
life insurance company, has a carryover from 1958 of $9,000, a carryover 
from 1959 of $6,000, a carryback from 1961 of $18,000, and a carryback 
from 1962 of $10,000, or an aggregate of $43,000 in carryovers and 
carrybacks. Thus, the operations loss deduction for 1960, for purposes 
of determining the tax liability for 1960, is $43,000. However, in 
computing the offset for 1960 which is subtracted from the loss from 
operations for 1961 for the purpose of determining the portion of such 
loss which may be carried over to subsequent taxable years, the 
operations loss deduction for 1960 is $15,000, that is, the aggregate of 
the $9,000 carryover from 1958 and the $6,000 carryover from 1959. In 
computing the operations loss deduction for such purpose, the $18,000 
carryback from 1961 and the $10,000 carryback from 1962 are disregarded. 
In computing the offset for 1960, however, which is subtracted from the 
loss from operations for 1962 for the purpose of determining the portion 
of such 1962 loss which may be carried over for subsequent taxable 
years, the operations loss deduction for 1960 is $33,000, that is, the 
aggregate of the $9,000 carryover from 1958, the $6,000 carryover from 
1959, and the $18,000 carryback from 1961. In computing the operations 
loss deduction for such purpose, the $10,000 carryback from 1962 is 
disregarded.

    (2) Recomputation of deductions limited by section 809(f)--(i) In 
general. If in any taxable year a life insurance company has deductions 
under section 809(d) (3), (5), and (6), as limited by section 809(f), 
and sustains a loss from operations in a succeeding taxable year which 
may be carried back as an operations loss deduction, such limitation and 
deductions shall be recomputed. This recomputation is required since the 
carryback must be taken into account for purposes of determining such 
limitation and deductions.
    (ii) Illustration of principles. The provisions of this subparagraph 
may be illustrated by the following example:

    (a) Facts. The books of P, a life insurance company, reveal the 
following facts:

----------------------------------------------------------------------------------------------------------------
                                                                      Taxable                                   
                          Taxable year                              investment       Gain from       Loss from  
                                                                      income        operations      operations  
----------------------------------------------------------------------------------------------------------------
1959............................................................      $9,000,000     $10,000,000  ..............
1960............................................................  ..............  ..............    ($9,800,000)
----------------------------------------------------------------------------------------------------------------

The gain from operations thus shown is computed without regard to any 
operations loss deduction or deductions under section 809(d) (3), (5), 
and (6), as limited by section 809(f). Assume that for the taxable year 
1959, P has (without regard to the limitation of section 809(f) or the 
operations loss deduction for 1959) a deduction under section 809(d)(3) 
of $2,500,000 for dividends to policyholders and no deductions under 
section 809(d) (5) or (6).
    (b) Determination of section 809(f) limitation and deduction for 
dividends to policyholders without regard to the operations loss 
deduction for 1959. In order to determine gain or loss from operations 
for 1959, P must determine the deduction for dividends to policyholders 
for such year. Under the provisions of section 809(f), the amount of 
such deduction shall not exceed the sum of (1) the amount (if any) by 
which the gain from operations for such year (determined without regard 
to such deduction) exceeds P's taxable investment income for such year, 
plus (2) $250,000. Since the gain from operations as thus determined 
($10,000,000) exceeds the taxable investment income ($9,000,000) by 
$1,000,000, the limitation on such deduction is $1,250,000 ($1,000,000 
plus $250,000). Accordingly, only $1,250,000 of the $2,500,000 deduction 
for dividends to policyholders shall be allowed. The gain from 
operations for such year is $8,750,000 ($10,000,000 minus $1,250,000).
    (c) Recomputation of section 809(f) limitation and deduction for 
dividends to policyholders

[[Page 557]]

after application of the operations loss deduction for 1959. Since P has 
sustained a loss from operations for 1960 which shall be carried back to 
1959 as an operations loss deduction, it must recompute the section 
809(f) limitation and deduction for dividends to policyholders. Taking 
into account the $9,800,000 operations loss deduction for 1959 reduces 
gain from operations for such year to $200,000 ($10,000,000 minus 
$9,800,000). Since the gain from operations as thus determined 
($200,000) is less than the taxable investment income ($9,000,000), the 
limitation on the deduction for dividends to policyholders is $250,000. 
Thus, only $250,000 of the $2,500,000 deduction for dividends to 
policyholders shall be allowed. The gain from operations for such year 
as thus determined is $9,750,000 ($10,000,000 minus $250,000) since for 
purposes of this determination the operations loss deduction for 1959 is 
not taken into account (see section 812(c)(1)). Accordingly, the offset 
for 1959 is $9,750,000 (the increase in the operations loss deduction 
for 1959, computed without regard to the carryback for 1960, which 
reduces life insurance company taxable income for 1959 to zero); thus, 
the portion of the 1960 loss from operations which shall be carried 
forward to 1961 is $50,000 (the excess of the 1960 loss ($9,800,000) 
over the offset for 1959 ($9,750,000)).

    (3) Minimum limitation. The life insurance company taxable income, 
as modified under this paragraph, shall in no case be considered less 
than zero.

[T.D. 6535, 26 FR 537, Jan. 20, 1961]



Sec. 1.812-6   New company defined.

    Section 812(e) provides that for purposes of part I, subchapter L, 
chapter 1 of the Code, a life insurance company is a ``new company'' for 
any taxable year only if such taxable year begins not more than 5 years 
after the first day on which it (or any predecessor if section 
381(c)(22) applies or would have applied if in effect) was authorized to 
do business as an insurance company.

[T.D. 7326, 39 FR 35354, Oct. 1, 1974]



Sec. 1.812-7   Application of subtitle A and subtitle F.

    Section 812(f) provides that except as modified by section 809(e) 
(relating to modifications of deduction items otherwise allowable under 
subtitle A of the Code) subtitles A and F of the Code shall apply to 
operations loss carrybacks and carryovers, and to the operations loss 
deduction, in the same manner and to the same extent that such subtitles 
apply in respect of net operation loss carrybacks, net operating loss 
carryovers, and the net operating loss deduction of corporations 
generally. For the computation of the operations loss carrybacks and 
carryovers, and of the operations loss deduction in the case of certain 
acquisitions of the assets of a life insurance company by another life 
insurance company, see section 381(c)(22) and the regulations 
thereunder.

[T.D. 6535, 26 FR 539, Jan. 20, 1961]



Sec. 1.812-8   Illustration of operations loss carrybacks and carryovers.

    The application of Sec. 1.812-4 may be illustrated by the following 
example:

    (a) Facts. The books of M, a life insurance company, organized in 
1940, reveal the following facts:

------------------------------------------------------------------------
                                        Taxable                         
            Taxable year              investment   Gain from   Loss from
                                        income    operations  operations
------------------------------------------------------------------------
1958................................     $11,000     $15,000  ..........
1959................................      23,000      30,000  ..........
1960................................  ..........  ..........   ($75,000)
1961................................      25,000      20,000  ..........
1962................................  ..........  ..........   (150,000)
1963................................      22,000      30,000  ..........
1964................................      40,000      35,000  ..........
1965................................      62,000      75,000  ..........
1966................................      25,000      17,000  ..........
1967................................      39,000      53,000  ..........
------------------------------------------------------------------------

The gain from operations thus shown is computed without regard to any 
operations loss deduction. The assumption is also made that none of the 
other modifications prescribed in paragraph (b) of Sec. 1.812-5 apply. 
There are no losses from operations for 1955, 1956, 1957, 1968, 1969, 
1970.
    (b) Loss sustained in 1960. The portions of the $75,000 loss from 
operations for 1960 which shall be used as carrybacks to 1958 and 1959 
and as carryovers to 1961, 1962, 1963, 1964, and 1965 are computed as 
follows:
    (1) Carryback to 1958. The carryback to this year is $75,000, that 
is, the amount of the loss from operations.
    (2) Carryback to 1959. The carryback to this year is $60,000 (the 
excess of the loss for 1960 over the offset for 1958), computed as 
follows:

Loss from operations........................................     $75,000
Less:                                                                   
  Offset for 1958 (the $15,000 gain from operations for such            
   year computed without the deduction of the carryback from            
   1960)....................................................      15,000
                                                 -------------          
    Carryback...............................................      60,000
                                                                        

    (3) Carryover to 1961. The carryover to this year is $30,000 (the 
excess, if any, of the loss

[[Page 558]]

for 1960 over the sum of the offsets for 1958 and 1959), computed as 
follows:

Loss from operations........................................    $75,000 
Less:                                                                   
  Offset for 1958 (the $15,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960)........     $15,000            
  Offset for 1959 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960 or the                          
   carryback from 1962).........................      30,000            
                                                 ------------           
    Sum of offsets..........................................      45,000
                                                 -------------          
    Carryover...............................................      30,000
                                                                        

    (4) Carryover to 1962. The carryover to this year is $10,000 (the 
excess, if any, of the loss for 1960 over the sum of the offsets for 
1958, 1959, and 1961), computed as follows:

Loss from operations........................................    $75,000 
Less:                                                                   
  Offset for 1958 (the $15,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960)........     $15,000            
  Offset for 1959 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960 or the                          
   carryback from 1962).........................      80,000            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1960 or the                          
   carryback from 1962).........................      20,000            
                                                 ------------           
    Sum of offsets..........................................      65,000
                                                 -------------          
    Carryover...............................................      10,000
                                                                        

    (5) Carryover to 1963. The carryover to this year is $10,000 (the 
excess, if any, of the loss for 1960 over the sum of the offsets for 
1958, 1959, 1961, and 1962), computed as follows:

Loss from operations........................................    $75,000 
Less:                                                                   
  Offset for 1958 (the $15,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960)........     $15,000            
  Offset for 1959 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960 or the                          
   carryback from 1962).........................      30,000            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1960 or the                          
   carryback from 1962).........................      20,000            
  Offset for 1962 (a year in which a loss from                          
   operations was sustained)....................           0            
                                                 ------------           
    Sum of offsets..........................................      65,000
                                                 -------------          
    Carryover...............................................      10,000
                                                                        

    (6) Carryover to 1964. The carryover to this year is $0 (the excess, 
if any, of the loss from 1960 over the sum of the offsets for 1958, 
1959, 1961, 1962, and 1963), computed as follows:

Loss from operations........................................    $75,000 
Less:                                                                   
  Offset for 1958 (the $15,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960)........     $15,000            
  Offset for 1959 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960 or the                          
   carryback from 1962).........................      30,000            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1960 or the                          
   carryback from 1962).........................      20,000            
  Offset for 1962 (a year in which a loss from                          
   operations was sustained)....................           0            
  Offset for 1963 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1960 or the                          
   carryover from 1962).........................      30,000            
                                                 ------------           
    Sum of offsets..........................................      95,000
                                                 -------------          
    Carryover...............................................           0
                                                                        

    (7) Carryover to 1965. The carryover to this year is $0 (the excess, 
if any, of the loss from 1960 over the sum of the offsets for 1958, 
1959, 1961, 1962, 1963, and 1964), computed as follows:

Loss from operations........................................    $75,000 
Less:                                                                   
  Offset for 1958 (the $15,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryback from 1960)........     $15,000            
  Offset for 1959 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction for the carryback from 1960 or the                         
   carryback from 1962).........................      30,000            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year computed without the                        
   deduction for the carryover from 1960 or the                         
   carryback from 1962).........................      20,000            
  Offset for 1962 (a year in which a loss from                          
   operations was sustained)....................           0            

[[Page 559]]

                                                                        
  Offset for 1963 (the $30,000 gain from                                
   operations for such year computed without the                        
   deduction for the carryover from 1960 or the                         
   carryover from 1962).........................      30,000            
  Offset for 1964 (the $35,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1960 or the                          
   carryover from 1962).........................      35,000            
                                                 ------------           
    Sum of offsets..........................................     130,000
                                                 -------------          
    Carryover...............................................           0
                                                                        

    (c) Loss sustained in 1962. The portions of the $150,000 loss from 
operations for 1962 which shall be used as carrybacks to 1959, 1960, and 
1961 and as carryovers to 1963, 1964, 1965, 1966, and 1967 are computed 
as follows:
    (1) Carryback to 1959. The carryback to this year is $150,000, that 
is, the amount of the loss from operations.
    (2) Carryback to 1960. The carryback to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the offset for 1959), 
computed as follows:

Loss from operations........................................    $150,000
Less:                                                                   
  Offset for 1959 (the $30,000 gain from operations for such            
   year reduced by the carryback to such year of $60,000                
   from 1960, the carryback from 1962 to 1959 not being                 
   taken into account)......................................           0
                                                 -------------          
    Carryback...............................................     150,000
                                                                        

    (3) Carryback to 1961. The carryback to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959 and 1960), computed as follows:

Loss from operations........................................    $150,000
Less:                                                                   
  Offset for 1959 (the $30,000 gain from operations for such            
   year reduced by the carryback to such year of $60,000                
   from 1960, the carryback from 1962 to 1959 not being                 
   taken into account)......................................           0
  Offset for 1960 (a year in which a loss from operations               
   was sustained)...........................................           0
                                                 -------------          
    Sum of offsets..........................................           0
                                                 -------------          
    Carryback...............................................     150,000
                                                                        

    (4) Carryover to 1963. The carryover to this year is $150,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, and 1961), computed as follows:

Loss from operations........................................    $150,000
Less:                                                                   
  Offset for 1959 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryback to such year of $60,000 from 1960,                         
   the carryback from 1962 to 1959 not being                            
   taken into account)..........................           0            
  Offset for 1960 (a year in which a loss from                          
   operations was sustained)....................           0            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $30,000 from 1960,                         
   the carryback from 1962 to 1961 not being                            
   taken into account)..........................           0            
                                                 ------------           
    Sum of offsets..........................................           0
                                                 -------------          
    Carryover...............................................     150,000
                                                                        

    (5) Carryover to 1964. The carryover to this year is $130,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, and 1963), computed as follows:

Loss from operations........................................    $150,000
Less:                                                                   
  Offset for 1959 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryback to such year of $60,000 from 1960,                         
   the carryback from 1962 to 1959 not being                            
   taken into account)..........................           0            
  Offset for 1960 (a year in which a loss from                          
   operations was sustained)....................           0            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $30,000 from 1960,                         
   the carryback from 1962 to 1961 not being                            
   taken into account)..........................           0            
  Offset for 1963 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $10,000 from 1960,                         
   the carryover from 1962 to 1963 not being                            
   taken into account)..........................      20,000            
                                                 ------------           
  Sum of offsets............................................      20,000
                                                 -------------          
    Carryover...............................................     130,000
                                                                        

    (6) Carryover to 1965. The carryover to this year is $95,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, and 1964), computed as follows:

Loss from operations........................................   $150,000 
Less:                                                                   
  Offset for 1959 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryback to such year of $60,000 from 1960,                         
   the carryback from 1962 to 1959 not being                            
   taken into account)..........................           0            
  Offset for 1960 (a year in which a loss from                          
   operations was sustained)....................           0            

[[Page 560]]

                                                                        
  Offset for 1961 (the $20,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $30,000 from 1960                          
   the carryback from 1962 to 1961 not being                            
   taken into account)..........................           0            
  Offset for 1963 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $10,000 from 1960,                         
   the carryover from 1962 to 1963 not being                            
   taken into account)..........................      20,000            
  Offset for 1964 (the $35,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $0 from 1960, the                          
   carryover from 1962 to 1964 not being taken                          
   into account)................................      35,000            
                                                 ------------           
    Sum of offsets..........................................      55,000
                                                 -------------          
    Carryover...............................................      95,000
                                                                        

    (7) Carryover to 1966. The carryover to this year is $20,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, 1964, and 1965), computed as follows:

Loss from operations........................................   $150,000 
Less:                                                                   
  Offset for 1959 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryback to such year of $60,000 from 1960,                         
   the carryback from 1962 to 1959 not being                            
   taken into account)..........................           0            
  Offset for 1960 (a year in which a loss from                          
   operations was sustained)....................           0            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $30,000 from 1960,                         
   the carryback from 1962 to 1961 not being                            
   taken into account)..........................           0            
  Offset for 1963 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryover for such year of $10,000 from 1960,                        
   the carryover from 1962 to 1963 not being                            
   taken into account)..........................      20,000            
  Offset for 1964 (the $35,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $0 from 1960, the                          
   carryover from 1962 to 1964 not being taken                          
   into account)................................      35,000            
  Offset for 1965 (the $75,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $0 to 1960, the                            
   carryover from 1962 to 1965 not being taken                          
   into account)................................     $75,000            
                                                 ------------           
    Sum of offsets..........................................    $130,000
                                                 -------------          
    Carryover...............................................      20,000
                                                                        

    (8) Carryover to 1967. The carryover to this year is $3,000 (the 
excess, if any, of the loss from 1962 over the sum of the offsets for 
1959, 1960, 1961, 1963, 1964, 1965, and 1966), computed as follows:

Loss from operations........................................    $150,000
Less:                                                                   
  Offset for 1959 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryback to such year of $60,000 from 1960,                         
   the carryback from 1962 to 1959 not being                            
   taken into account)..........................           0            
  Offset for 1960 (a year in which a loss from                          
   operations was sustained)....................           0            
  Offset for 1961 (the $20,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $30,000 from 1960,                         
   the carryback from 1962 to 1961 not being                            
   taken into account)..........................           0            
  Offset for 1963 (the $30,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $10,000 from 1960,                         
   the carryover from 1962 to 1963 not being                            
   taken into account)..........................      20,000            
  Offset for 1964 (the $35,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $0 from 1960, the                          
   carryover from 1962 to 1964 not being taken                          
   into account)................................      35,000            
  Offset for 1965 (the $75,000 gain from                                
   operations for such year reduced by the                              
   carryover to such year of $0 from 1960, the                          
   carryover from 1962 to 1965 not being taken                          
   into account)................................      75,000            
  Offset for 1966 (the $17,000 gain from                                
   operations for such year computed without the                        
   deduction of the carryover from 1962)........      17,000            
                                                 ------------           
    Sum of offsets..........................................     147,000
                                                 -------------          
    Carryover...............................................       3,000
                                                                        

    (d) Determination of operations loss deduction for each year. The 
carryovers and carrybacks computed under paragraphs (b) and (c) of

[[Page 561]]

this section are used as a basis for the computation of the operations 
loss deduction in the following manner:

----------------------------------------------------------------------------------------------------------------
                                                                 Carryover            Carryback                 
                                                           ------------------------------------------ Operations
                       Taxable year                           From                 From                  loss   
                                                              1960    From 1962    1960    From 1962  deductions
----------------------------------------------------------------------------------------------------------------
1958......................................................  ........  .........   $75,000  .........    $75,000 
1959......................................................  ........  .........    60,000   $150,000    210,000 
1961......................................................   $30,000  .........  ........    150,000    180,000 
1963......................................................    10,000   $150,000  ........  .........    160,000 
1964......................................................  ........    130,000  ........  .........    130,000 
1965......................................................  ........     95,000  ........  .........     95,000 
1966......................................................  ........     20,000  ........  .........     20,000 
1967......................................................  ........      3,000  ........  .........      3,000 
----------------------------------------------------------------------------------------------------------------

[T.D. 6535, 26 FR 539, Jan. 20, 1961]

                      Distributions to Shareholders



Sec. 1.815-1   Taxable years affected.

    Sections 1.815-2 through 1.815-6, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112), the Act of October 10, 1962 (76 Stat. 808), and the Act of October 
23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]



Sec. 1.815-2   Distributions to shareholders.

    (a) In general. Section 815 provides that every stock life insurance 
company subject to the tax imposed by section 802 shall establish and 
maintain two special surplus accounts for Federal income tax purposes. 
These special accounts are the shareholders surplus account (as defined 
in section 815(b) and Sec. 1.815-3) and the policyholders surplus 
account (as defined in section 815(c) and Sec. 1.815-4). To the extent 
that a distribution to shareholders (as defined in paragraph (c) of this 
section) is treated as being made out of the shareholders surplus 
account, no tax is imposed on the company with respect to such 
distribution. However, to the extent that a distribution to shareholders 
is treated as being made out of the policyholders surplus account, the 
amount subtracted from the policyholders surplus account by reason of 
such distribution shall be taken into account in determining life 
insurance company taxable income under section 802(b).
    (b) Priority system for distributions to shareholders. (1) For 
purposes of section 815 (other than subsection (e) thereof relating to 
certain mutualizations) and section 802(b)(3) (relating to the 
determination of life insurance company taxable income), any 
distribution made to shareholders after December 31, 1958, shall be 
treated in the following manner:
    (i) Distributions shall be treated as first being made out of the 
shareholders surplus account (as defined in section 815(b) and 
Sec. 1.815-3);
    (ii) Once the shareholders surplus account has been reduced to zero, 
distributions shall then be treated as being made out of the 
policyholders surplus account (as defined in section 815(c) and 
Sec. 1.815-4) until that account has been reduced to zero; and
    (iii) Finally, any distributions in excess of the amounts in the 
shareholders surplus account and the policyholders surplus account shall 
be treated as being made out of other accounts (as defined in 
Sec. 1.815-5).
    (2) For purposes of subparagraph (1) of this paragraph, in order to 
determine whether a distribution (or any portion thereof) shall be 
treated as being made out of the shareholders surplus account, 
policyholders surplus account, or other accounts, the amount in such 
accounts at the end of any taxable year shall be the cumulative balance 
in such accounts at the end of the taxable year, computed without 
diminution by reason of a distribution (or any portion thereof) during 
the taxable

[[Page 562]]

year which is treated as being made out of such accounts. For example, 
on January 1, 1960, S, a stock life insurance company, had $1,000 in its 
shareholders surplus account and $3,000 in its policyholders surplus 
account. On November 1, 1960, S distributed $4,000 to its shareholders. 
Under the provisions of section 815(b)(2) and paragraph (b) of 
Sec. 1.815-3, S added $5,000 to its shareholders surplus account for the 
taxable year 1960. Since the distributions to shareholders during the 
taxable year 1960, $4,000, does not exceed the cumulative balance in the 
shareholders surplus account at the end of the taxable year, computed 
without diminution by reason of distributions treated as made out of 
such account during the taxable year, $6,000 ($1,000 plus $5,000), the 
entire distribution is treated as being made out of the shareholders 
surplus account.
    (3) Except in the case of a distribution in cash and as otherwise 
provided herein, the amount to be charged to the special surplus 
accounts referred to in subparagraph (1) of this paragraph with respect 
to any distributions to shareholders (as defined in section 815(a) and 
paragraph (c) of this section) shall be the fair market value of the 
property distributed, determined as of the date of distribution. 
However, for the amount of the adjustment to earnings and profits 
reflecting such distributions, see section 312 and the regulations 
thereunder. For a special rule relating to the determination of the 
amount to be charged to such special surplus accounts in the case of a 
distribution by a foreign life insurance company carrying on a life 
insurance business within the United States, see section 819(c)(1) and 
the regulations thereunder.
    (c) Distributions to shareholders defined. (1) Except as otherwise 
provided in section 815(f) and subparagraph (2) of this paragraph, the 
term distribution, as used in section 815(a) and paragraph (b) of this 
section, means any distribution of property made by a life insurance 
company to its shareholders. For purposes of the preceding sentence, the 
term property means any property (including money, securities, and 
indebtedness to the company) other than stock, or rights to acquire 
stock, in the company making the distribution. Thus, for example, the 
term includes a distribution which is considered a dividend under 
section 316, but is not limited to the extent that such distribution 
must be made out of the accumulated or current earnings and profits of 
the company making the distribution. For example, except as otherwise 
provided in section 815(f) and subparagraph (2) of this paragraph, there 
is a distribution within the meaning of this paragraph in any case in 
which a corporation acquires the stock of a shareholder in exchange for 
property in a redemption treated as a distribution in exchange for stock 
under section 302(a) or treated as a distribution of property under 
section 302(d). For special rules relating to distributions to 
shareholders in acquisition of stock pursuant to a plan of 
mutualization, see section 815(e) and paragraph (e) of Sec. 1.815-6.
    (2) The term distribution, as used in section 815(a) and paragraph 
(b) of this section, does not (except for purposes of section 815(a)(3) 
and (e)(2)(B)) include any distribution in redemption of stock issued 
prior to January 1, 1958, where such stock was at all times on and after 
the date of its issuance and on and before the date of its redemption 
limited as to the amount of dividends payable and was callable, at the 
option of the issuer, at a price not in excess of 105 percent of the sum 
of its issue price plus the amount of contribution to surplus (if any) 
made by the original purchaser at the time of his purchase.

[T.D. 6535, 26 FR 542, Jan. 20, 1961, as amended by T.D. 7189, 37 FR 
12793, June 29, 1972]



Sec. 1.815-3   Shareholders surplus account.

    (a) In general. Every stock life insurance company subject to the 
tax imposed by section 802 shall establish and maintain a shareholders 
surplus account. This account shall be established as of January 1, 
1958, and the beginning or opening balance of the shareholders surplus 
account on that date shall be zero.
    (b) Additions to shareholders surplus account. (1) The amount added 
to the shareholders surplus account for any taxable year beginning after 
December

[[Page 563]]

31, 1957, shall be the amount by which the sum of:
    (i) The life insurance company taxable income (computed without 
regard to section 802(b)(3)),
    (ii) In the case of a taxable year beginning after December 31, 
1958, the amount (if any) by which the net long-term capital gain 
exceeds the net short-term capital loss, reduced (in the case of a 
taxable year beginning after December 31, 1961) by the amount referred 
to in subdivision (i) of this subparagraph,
    (iii) The deduction for partially tax-exempt interest provided by 
section 242 (as modified by section 804(a)(3)), the deductions for 
dividends received provided by sections 243, 244, and 245 (as modified 
by section 809(d)(8)(B)), and the amount of interest excluded from gross 
income under section 103, and
    (iv) The small business deduction provided by section 809(d)(10). 
Exceeds the taxes imposed for the taxable year by section 802(a), 
computed without regard to section 802(b)(3).
    (c) Subtractions from shareholders surplus account--(1) In general. 
There shall be subtracted from the cumulative balance in the 
shareholders surplus account at the end of any taxable year, computed 
without diminution by reason of distributions made during the taxable 
year, the amount which is treated as being distributed out of such 
account under section 815(a) and paragraph (b) of Sec. 1.815-2.
    (2) Special rule; distributions in 1958. There shall be subtracted 
from the shareholders surplus account (to the extent thereof) for any 
taxable year beginning in 1958 the amount of the distributions to 
shareholders made by the company during 1958. For example, assume S, a 
stock life insurance company, had additions to its shareholders surplus 
account (as determined under section 815(b)(2) and paragraph (b) of this 
section) for the taxable year 1958 of $10,000, and actually distributed 
as dividends to its shareholders $8,000 during the year 1958. The 
balance in S's shareholders surplus account as of January 1, 1959, shall 
be $2,000. If S had distributed $12,000 as dividends in 1958, the 
balance in its shareholders surplus account as of January 1, 1959, would 
be zero and the other accounts referred to in section 815(a)(3) and 
paragraph (b)(1)(iii) of Sec. 1.815-2 would be reduced by $2,000.
    (d) Illustration of principles. The application of section 815(b) 
and this section may be illustrated by the following example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960.

Balance in shareholders surplus account as of 1-1-60........      $5,000
Life insurance company taxable income computed without                  
 regard to sec. 802(b)(3)...................................       4,000
Excess of net long-term capital gain over net short-term                
 capital loss...............................................       1,700
Tax-exempt interest included in gross investment income                 
 under sec. 804(b)..........................................         100
Small business deduction (determined under sec. 809(d)(10)).         200
Tax liability under sec. 802(a) (1) and (2) computed without            
 regard to sec. 802(b)(3)...................................       1,625
Amount distributed to shareholders..........................       9,000
                                                                        

For purposes of determining the amount to be subtracted from its 
shareholders surplus account for the taxable year, S would first make up 
the following schedule in order to determine the cumulative balance in 
the shareholders surplus account at the end of the taxable year, 
computed without diminution by reason of distributions made during the 
taxable year:

(1) Balance in shareholders surplus account as of 1-1-60....      $5,000
(2) Additions to account:                                               
  (a) Life insurance company taxable income                             
   computed without regard to sec. 802(b)(3)....      $4,000            
  (b) Excess of net long-term capital gain over                         
   net short-term capital loss..................       1,700            
  (c) Tax-exempt interest included in gross                             
   investment income under sec. 804(b)..........         100            
  (d) Small business deduction (determined under                        
   sec. 809(d)(10)).............................         200            
                                                 ------------           
    Total.......................................       6,000            
Less:                                                                   
  Tax liability under sec. 802(a) (1) and (2)                           
   computed without regard to sec. 802(b)(3)....       1,625            
                                                   ---------       4,375
                                                 -------------          
(3) Cumulative balance in shareholders surplus account as of            
 12-31-60 (item (1) plus item (2))..........................       9,375
                                                                        


[[Page 564]]

Since the amount distributed to shareholders during the taxable year, 
$9,000, does not exceed the cumulative balance in the shareholders 
surplus account at the end of the taxable year, computed without 
diminution by reason of distributions made during the taxable year, 
$9,375, under the provisions of section 815(a), the entire distribution 
shall be treated as being made out of the shareholders surplus account. 
Thus, $9,000 shall be subtracted from the shareholders surplus account 
(leaving a balance of $375 in such account at the end of the taxable 
year) and S shall incur no additional tax liability by reason of the 
distribution to its shareholders during the taxable year 1960.

[T.D. 6535, 26 FR 542, Jan. 20, 1961, as amended by T.D. 7189, 37 FR 
12793, June 29, 1972]



Sec. 1.815-4   Policyholders surplus account.

    (a) In general. Every stock life insurance company subject to the 
tax imposed by section 802 shall establish and maintain a policyholders 
surplus account. This account shall be established as of January 1, 
1959, and the beginning or opening balance of the policyholders surplus 
account on that date shall be zero.
    (b) Additions to policyholders surplus account. The amount added to 
the policyholders surplus account for any taxable year beginning after 
December 31, 1958, shall be the sum of:
    (1) An amount equal to 50 percent of the amount by which the gain 
from operations for the taxable year exceeds the taxable investment 
income,
    (2) The deduction allowed or allowable under section 809(d)(5) (as 
limited by section 809(f)) for certain nonparticipating contracts, and
    (3) The deduction allowed or allowable under section 809(d)(6) (as 
limited by section 809(f)) for taxable years beginning before January 1, 
1963, for group life and group accident and health insurance contracts, 
and for taxable years beginning after December 31, 1962, for accident 
and health insurance and group life insurance contracts.
    (c) Subtractions from policyholders surplus account--(1) In general. 
There shall be subtracted from the cumulative balance in the 
policyholders surplus account at the end of any taxable year, computed 
without diminution by reason of distributions made during the taxable 
year, an amount equal to the sum of:
    (i) The amount which (without regard to subdivision (ii) of this 
subparagraph) is treated under section 815(a) as distributed out of the 
policyholders surplus account for the taxable year, plus
    (ii) The amount (determined without regard to section 802(a)(3)) by 
which the tax imposed for taxable years beginning before January 1, 
1962, by section 802(a)(1), and for taxable years beginning after 
December 31, 1961, by section 802(a), is increased by reason of section 
802(b)(3).

In addition, there shall be subtracted from the policyholders surplus 
account for the taxable year those amounts which, at the close of the 
taxable year, are subtracted or treated as subtracted from the 
policyholders surplus account under section 815(d) (1) and (4) and 
paragraphs (a) and (d) of Sec. 1.815-6. For purposes of this paragraph, 
the subtractions from the policyholders surplus account shall be treated 
as made in the following order:
    (a) First the amount determined under section 815(c)(3) by reason of 
distributions to shareholders during the taxable year which are treated 
as being made out of the policyholders surplus account;
    (b) Next the amount elected to be subtracted from the policyholders 
surplus account for the taxable year under section 815(d)(1);
    (c) Then the amount which is treated as a subtraction from the 
policyholders surplus account for the taxable year by reason of the 
limitation provided in section 815(d)(4); and
    (d) Finally the amount taken into account upon termination as a life 
insurance company as provided in section 815(d)(2).
    (2) Method of computing amount subtracted from policyholders surplus 
account--(i) Where life insurance company taxable income, computed 
without regard to section 802(b)(3), exceeds $25,000. If the life 
insurance company taxable income for any taxable year computed under 
section 802(b), computed without regard to section 802(b)(3), exceeds 
$25,000, the amount subtracted from the policyholders surplus account 
shall be determined by multiplying the

[[Page 565]]

amount treated as distributed out of such account by a ratio, the 
numerator of which is 100 percent and the denominator of which is 100 
percent minus the sum of the normal tax rate and the surtax rate for the 
taxable year.
    (ii) Where life insurance company taxable income does not exceed 
$25,000. If the life insurance company taxable income for any taxable 
year, computed under section 802(b), does not exceed $25,000, the amount 
subtracted from the policyholders surplus account shall be determined by 
multiplying the amount treated as distributed out of such account by a 
ratio, the numerator of which is 100 percent and the denominator of 
which is 100 percent minus the normal tax rate for the taxable year.
    (iii) Where life insurance company taxable income, computed without 
regard to section 802(b)(3) does not exceed $25,000, but computed with 
regard to section 802(b)(3) does exceed $25,000. If the life insurance 
company taxable income for any taxable year, computed without regard to 
section 802(b)(3) does not exceed $25,000, but computed with regard to 
section 802(b)(3) does exceed $25,000, the amount subtracted from the 
policyholders surplus account shall be determined in the following 
manner:
    (a) First, determine the amount by which $25,000 exceeds the amount 
determined under section 802(b) (1) and (2);
    (b) Then, multiply the amount determined under (a) by a ratio, the 
numerator of which is 100 percent minus the normal tax rate and the 
denominator of which is 100 percent;
    (c) Next, determine the amount by which the amount treated as 
distributed out of the policyholders surplus account exceeds the amount 
determined under (b) and multiply such excess by a ratio, the numerator 
of which is 100 percent and the denominator of which is 100 percent 
minus the sum of the normal tax rate and the surtax rate; and
    (d) Finally, add the amounts determined under (a) and (c).
    (3) Illustration of principles. The application of section 815(c)(3) 
and subparagraph (2) of this paragraph may be illustrated by the 
following examples:

    Example 1. The life insurance company taxable income of S, a stock 
life insurance company, computed without regard to section 802(b)(3), 
exceeds $25,000 for the taxable year 1959. Assume that of the amount 
distributed by S to its shareholders during the taxable year, $9,600 (as 
determined under section 815(a) and without regard to section 
815(c)(3)(B)) is treated as distributed out of the policyholders surplus 
account. Since the sum of the normal tax rate (30%) and the surtax rate 
(22%) in effect for 1959 is 52 percent. S shall subtract $20,000 from 
its policyholders surplus account for the taxable year 1959, computed as 
follows:
$9,600 x 100/(100-52)=$9,600 x 100/48=$20,000
Of this amount, $9,600 is due to the application of section 815(c)(3)(A) 
and $10,400 to the application of section 815(c)(3)(B).
    Example 2. Assume that for the taxable year 1960, S, a stock life 
insurance company, has taxable investment income of $1,000 and a gain 
from operations of $2,000. Assume further that of the amount distributed 
by S to its shareholders during the taxable year, $3,500 (as determined 
under section 815(a) and without regard to section 815(c)(3)(B)) is 
treated as distributed out of the policyholders surplus account. Since 
S's life insurance company taxable income does not exceed $25,000 for 
the taxable year and the normal tax rate in effect for 1960 is 30 
percent, S shall subtract $5,000 from its policyholders surplus account 
for the taxable year 1960, computed as follows:

$3,500 x 100/(100-30)=$3,500 x 100/70=$5,000


Of this amount, $3,500 is due to the application of section 
815(c)(3)(A), and $1,500 to the application of section 815(c)(3)(B).
    Example 3. For the taxable year 1960, the life insurance company 
taxable income of S, a stock life insurance company, computed without 
regard to section 802(b)(3), is $10,000. Assume that of the amount 
distributed by S to its shareholders during the taxable year, $12,000 
(as determined under section 815(a) and without regard to section 
815(c)(3)(B)) is treated as distributed out of the policyholders surplus 
account. Since the life insurance company taxable income of S, computed 
with regard to section 802(b)(3), exceeds $25,000, in order to determine 
the amount to be subtracted from its policyholders surplus account, S 
would make up the following schedule:

(1) $25,000 minus life insurance company taxable income,                
 computed without regard to sec. 802(b)(3) ($25,000 minus               
 $10,000.....................................................    $15,000
(2) Item (1) multiplied by 100 percent minus the normal tax             
 rate as in effect for 1960, over 100 percent                           
    ($15,000 x (100-30)100)..........................     10,500

[[Page 566]]

                                                                        
(3) Amount by which the amount treated as distributed out of            
 policyholders surplus account ($12,000) exceeds item (2)               
 ($10,500), multiplied by 100 percent over 100 percent minus            
 the sum of the normal tax rate and the surtax rate as in               
 effect for 1960                                                        
    ($1,500 x 100(100-52))...........................      3,125
(4) Item (1) plus item (3) ($15,000 plus $3,125).............     18,125
                                                                        

For the taxable year 1960, S shall subtract $18,125 from its 
policyholders surplus account. Of this amount, $10,500 represents the 
distribution from the policyholders surplus account which is taxed at a 
30 percent tax rate and $1,500 the distribution from the policyholders 
surplus account which is taxed at a 52 percent tax rate. Thus, of the 
amount subtracted from the policyholders surplus account for the taxable 
year 1960, $12,000 is due to the application of section 815(c)(3) (A), 
and $6,125 to the application of section 815(c)(3)(B).

    (d) Illustration of principles. The application of section 815(c) 
and this section may be illustrated by the following example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960:

Taxable investment income....................................    $25,000
Gain from operations.........................................     30,000
Tax base (sec. 802(b)(1) and (2))............................     27,500
Deduction for certain nonparticipating policies provided by             
 sec. 809(d)(5) (as limited by sec. 809(f))..................        600
Deduction for group policies provided by sec. 809(d)(6) (as             
 limited by sec. 809(f)).....................................        400
Amount distributed to shareholders...........................     60,000
Cumulative balance in shareholders surplus account as of 12-            
 31-60.......................................................     36,000
Balance in policyholders surplus account as of 1-1-60........     48,000
                                                                        

For purposes of determining the amount to be subtracted from its 
policyholders surplus account for the taxable year, S would first make 
up the following schedule in order to determine the cumulative balance 
in the policyholders surplus account at the end of the taxable year, 
computed without diminution by reason of distributions made during the 
taxable year:

(1) Balance in policyholders surplus account as of 1-1-60....    $48,000
(2) Additions to account:                                               
  (a) 50 percent of the amount by which the gain                        
   from operations ($30,000) exceeds the taxable                        
   investment income ($25,000) (1/2  x $5,000)....     $2,500           
  (b) The deduction for certain nonparticipating                        
   contracts provided by sec. 809(d)(5) (as                             
   limited by sec. 809(f))........................        600           
  (c) The deduction for group contracts provided                        
   by sec. 809(d)(6) (as limited by sec. 809(f))..        400           
                                                     --------      3,500
                                                   ------------         
(3) Cumulative balance in policyholders account as of 12-31-            
 60 (item (1) plus item (2)).................................     51,500
                                                                        

Under the provisions of section 815(a), since the amount distributed to 
shareholders during the taxable year, $60,000, exceeds the cumulative 
balance in the shareholders surplus at the end of the taxable year, 
computed without diminution by reason of distributions during the 
taxable year, $36,000, the shareholders surplus account shall first be 
reduced to zero. The remaining $24,000 ($60,000 minus $36,000) of the 
distribution shall then be treated as made out of the policyholders 
surplus account. Thus, since the tax base under section 802(b)(1) and 
(2) is in excess of $25,000, the total amount to be subtracted from the 
policyholders surplus account at the end of the taxable year would be 
$50,000 ($24,000 x 100(100-52)). Of this amount $26,000 ($50,000 
minus $24,000) represents the tax on the portion of the distribution to 
shareholders which is treated as being out of the policyholders surplus 
account.

    (e) Special rule for 1959 and 1960. For a special transitional rule 
applicable to any increase in tax liability under section 802(b)(3) for 
the taxable years 1959 and 1960 which is due solely to the operation of 
section 815(c)(3) and this section, see section 802(a)(3) and 
Sec. 1.802-5.

[T.D. 6535, 26 FR 543, Jan. 20, 1961, as amended by T.D. 6886, 31 FR 
8689, June 23, 1966]



Sec. 1.815-5   Other accounts defined.

    The term other accounts, as used in section 815(a)(3) and paragraph 
(b) of Sec. 1.815-2, means all amounts which are not specifically 
included in the shareholders surplus account under section 815(b) and 
paragraph (b) of Sec. 1.815-3, or in the policyholders surplus account 
under section 815(c) and paragraph (b) of Sec. 1.815-4. Thus, for 
example, other accounts includes amounts representing the increase in 
tax due to the operation of section 802(b)(3) which is not taken into 
account for the taxable years 1959 and 1960 because of the special 
transitional rule provided in section 802(a)(3) and Sec. 1.802-5, 
earnings and profits accumulated prior to January 1, 1958, paid-in 
surplus, capital, etc. To the extent that a distribution (or any portion 
thereof) is treated as being made out of other accounts, no tax is 
imposed on the company with respect to such distribution.

[T.D. 6535, 26 FR 544, Jan. 20, 1961]

[[Page 567]]



Sec. 1.815-6   Special rules.

    (a) Election to transfer amounts from policyholders surplus account 
to shareholders surplus account--(1) In general. Section 815(d)(1) 
permits a life insurance company to elect, after the close of any 
taxable year for which it is a life insurance company, to subtract any 
amount (or any portion thereof) in its policyholders surplus account as 
of the close of the taxable year. The effect of such election is to 
subject the company to tax on the amounts elected to be subtracted for 
the taxable year for which the election applies. The amount so 
subtracted, less the amount of tax imposed with respect to such amount 
by reason of section 802(b)(3), shall be added to the shareholders 
surplus account as of the beginning of the taxable year following the 
taxable year for which the election applies and no further tax shall be 
imposed upon the company if the amount elected to be transferred to the 
shareholders surplus account is subsequently distributed to 
shareholders.
    (2) Manner and effect of election. (i) The election provided by 
section 815(d)(1) and this section shall be made in a statement attached 
to the life insurance company's income tax return for any taxable year 
for which the company desires the election to apply. The statement shall 
include the name and address of the taxpayer, shall be signed by the 
taxpayer (or his duly authorized representative), and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the return for such taxable year. In addition, the statement 
shall indicate that the company has made the election provided under 
section 815(d)(1) for the taxable year and the amount elected to be 
subtracted from the policyholders surplus account.
    (ii) An election made under section 815(d)(1)(B) and subdivision (i) 
of this subparagraph shall be effective only with respect to the taxable 
year for which the election is made. Thus, the company must make a new 
election for each taxable year for which it desires the election to 
apply. Once such an election has been made for any taxable year it may 
not be revoked.
    (3) The application of subparagraph (1) of this paragraph may be 
illustrated by the following example:

    Example. For the taxable year 1960, the life insurance company 
taxable income of S, a stock life insurance company, computed without 
regard to section 802(b)(3), exceeds $25,000. Assume that S elects to 
subtract $20,000 from its policyholders surplus account under section 
815(d)(1) for the taxable year. Since S is subject to a 52 percent tax 
rate, the tax on the amount elected to be subtracted from the 
policyholders surplus account (as of the close of the taxable year 1960) 
is $10,400 ($20,000 x 52 percent). Thus, the amount to be added to the 
shareholders surplus account as of January 1, 1961, is $9,600 (the 
amount subtracted from the policyholders surplus account by virtue of 
the section 815(d)(1) election, less the tax imposed upon such amount by 
reason of section 802(b)(3), or $20,000 minus $10,400).

    (b) Termination as life insurance company--(1) Effect of 
termination. Except as provided in section 381(c)(22) (relating to 
carryovers in certain corporate readjustments), section 815(d)(2)(A) 
provides that if for any taxable year the taxpayer is not an insurance 
company (as defined in paragraph (a) of Sec. 1.801-3), or if for any two 
successive taxable years the taxpayer is not a life insurance company 
(as defined in section 801(a) and paragraph (b) of Sec. 1.801-3), the 
amount taken into account under section 802(b)(3) for the last preceding 
year for which the company was a life insurance company shall be 
increased (after the application of section 815(d)(2)(B)) by the entire 
balance in the policyholders surplus account at the close of such last 
preceding taxable year.
    (2) Effect of certain distributions. If for any taxable year the 
taxpayer is an insurance company (as defined in paragraph (a) of 
Sec. 1.801-3) but is not a life insurance company (as defined in section 
801(a) and paragraph (b) of Sec. 1.801-3), section 815(d)(2)(B) provides 
that any distribution to shareholders during such taxable year shall be 
treated as having been made on the last day of the last preceding 
taxable year for which the company was a life insurance company.
    (3) Examples. The application of section 815(d)(2) and this 
paragraph may be illustrated by the following examples:


[[Page 568]]


    Example 1. At the end of the taxable year 1959, the balance in the 
policyholders surplus account of S, a life insurance company within the 
meaning of section 801(a) and paragraph (b) of Sec. 1.801-3, is $12,000. 
If S fails to qualify as an insurance company (as defined in paragraph 
(a) of Sec. 1.801-3) for the taxable year 1960, and section 381(c)(22) 
does not apply, under the provisions of section 815(d)(2)(A), the entire 
balance of $12,000 in the policyholders surplus account at the end of 
1959, the last year S was a life insurance company, shall be taken into 
account under section 802(b)(3) for purposes of determining S's tax 
liability for the taxable year 1959.
    Example 2. Assume the facts are the same as in example 1, except 
that for the taxable years 1960 and 1961, S qualifies as an insurance 
company (as defined in paragraph (a) of Sec. 1.801-3) but does not 
qualify as a life insurance company within the meaning of section 801(a) 
and paragraph (b) of Sec. 1.801-3. Assume further that as a result of a 
distribution by S to its shareholders in 1960, $4,800 (as determined 
under section 815(a) and without regard to section 815(c)(3)(B)) is 
treated as distributed out of the policyholders surplus account. Under 
the provisions of section 815(d)(2)(B), if section 381(c)(22) does not 
apply, any distribution to shareholders during the taxable years 1960 
and 1961 shall be treated as having been made on December 31, 1959 (the 
last day of the last preceding taxable year for which S was a life 
insurance company). Thus, assuming S is subject to a 52 percent tax rate 
on additions to life insurance company taxable income, $10,000 ($4,800 
plus $5,200, the tax on the portion of the distribution treated as made 
out of the policyholders surplus account) shall be treated as being 
subtracted from the policyholders surplus account at the end of 1959 and 
shall be taken into account under section 802(b)(3) for purposes of 
determining S's tax liability for the taxable year 1959. Under the 
provisions of section 815(d)(2)(A), the entire balance of $2,000 
($12,000 minus $10,000) in the policyholders surplus account at the end 
of 1959 (after the application of section 815(d)(2)(B)), shall also be 
taken into account under section 802(b)(3) for purposes of determining 
S's tax liability for the taxable year 1959.

    (c) Treatment of certain indebtedness. Section 815(d)(3) provides 
that if a taxpayer makes any payment in discharge of its indebtedness 
and such indebtedness is attributable to a distribution by the taxpayer 
to its shareholders after February 9, 1959, the amount of such payment 
shall be treated as a distribution in cash to shareholders both for 
purposes of section 802(b)(3) and section 815. However, this paragraph 
shall only apply to the extent that the distribution of such 
indebtedness to shareholders was treated as being out of accounts other 
than the shareholders and policyholders surplus accounts at the time of 
distribution.
    (d) Limitation on amount in policyholders surplus account--(1) In 
general. Section 815(d)(4) provides a limitation on the amount that any 
life insurance company may accumulate in its policyholders surplus 
account. If the policyholders surplus account at the end of any taxable 
year (computed without regard to this paragraph) exceeds whichever of 
the following is the greatest:
    (i) 15 percent of life insurance reserves (as defined in section 
801(b) and paragraph (a) of Sec. 1.801-4) at the end of the taxable 
year.
    (ii) 25 percent of the amount by which the life insurance reserves 
at the end of the taxable year exceed the life insurance reserves at the 
end of 1958, or
    (iii) 50 percent of the net amount of the premiums and other 
consideration taken into account for the taxable year under section 
809(c)(1),

then such excess shall be treated as a subtraction from the 
policyholders surplus account as of the end of such taxable year. The 
amount so treated as subtracted, less the amount of tax imposed with 
respect to such amount by reason of section 802(b)(3), shall be added to 
the shareholders surplus account at the beginning of the succeeding 
taxable year.
    (2) Example. The application of the limitation contained in 
subparagraph (1) of this paragraph may be illustrated by the following 
example:

    Example. The books of S, a stock life insurance company, reflect the 
following items for the taxable year 1960:

Balance in policyholders surplus account, computed without              
 regard to sec. 815(d)(4), as of 12-31-60....................       $175
Life insurance reserves (as defined in sec. 801(b)) as of 12-           
 31-60.......................................................      4,500
Life insurance reserves (as defined in sec. 801(b)) as of 12-           
 31-58.......................................................      3,900
Premiums and other consideration taken into account for the             
 taxable year under sec. 809(c)(1)...........................        310
                                                                        

In order to determine the limitations on the amount that it may 
accumulate in its policyholders surplus account at the end of the 
taxable year under section 815(d)(4), S would make up the following 
schedule:

[[Page 569]]



(1) 15 percent of life insurance reserves at the end of the             
 taxable year (15% x $4,500).................................       $675
(2) 25 percent of amount by which life insurance reserves at            
 the end of the taxable year ($4,500) exceed life insurance             
 reserves as of 12-31-58 ($3,900) (25% x $600)...............        150
(3) 50 percent of premiums and other consideration taken into           
 account under sec. 809(c)(1) for the taxable year (50% x               
 $310).......................................................        155
(4) Limitation on policyholders surplus account (the greatest           
 of items (1), (2), or (3))..................................        675
                                                                        

Since the balance in the policyholders surplus account at the end of the 
taxable year 1960, $175, does not exceed the limitation provided by 
section 815(d)(4), $675, S is not required to make any further 
adjustment to its policyholders surplus account at the end of the 
taxable year.

    (e) Special rule for certain mutualizations--(1) In general. Section 
815(e) provides a rule for determining priorities which shall operate in 
place of section 815(a) and paragraph (b) of Sec. 1.815-2 where a life 
insurance company makes any distribution to its shareholders after 
December 31, 1958, in acquisition of stock pursuant to a plan of 
mutualization. Section 815(e)(1) provides that such a distribution shall 
first be treated as being made out of paid-in capital and paid-in 
surplus, and, to the extent thereof, no tax shall be imposed on the 
company with respect to such distribution. Thereafter, distributions 
made pursuant to such plan of mutualization shall be treated as made in 
two allocable parts. One part shall be treated as being made out of 
other accounts (as defined in Sec. 1.815-5) and the company shall incur 
no tax with respect to such portion of the distribution. The other part 
shall be treated as a distribution to which section 815(a) and paragraph 
(b) of Sec. 1.815-2 applies. Thus, such portion of the distribution 
shall be treated as first being made out of the shareholders surplus 
account (as defined in section 815(b) and Sec. 1.815-3), to the extent 
thereof, and then out of the policyholders surplus account (as defined 
in section 815(c) and Sec. 1.815-4), to the extent thereof. See 
paragraph (a) of Sec. 1.815-2. For purposes of this paragraph, a 
distribution shall be considered as being made pursuant to a plan of 
mutualization only if the requirements of applicable State law for the 
adoption of such plan (as, for example, approval by the requisite 
majority of the board of directors, shareholders, and policyholders) 
have been fulfilled.
    (2) Allocation ratio. Section 815(e)(2)(A) provides an allocation 
ratio which when applied to the amount distributed under a plan of 
mutualization in excess of the balance in the paid-in capital and paid-
in surplus accounts determines the portion of such excess to be treated 
as distributed out of the shareholders surplus account, policyholders 
surplus account, or other accounts. The numerator of this ratio is the 
excess of the assets of the company (as defined in section 805(b)(4) and 
paragraph (a)(4) of Sec. 1.805-5) over the total liabilities (including 
reserves), both determined as of December 31, 1958, and adjusted in the 
manner provided in subparagraph (3) of this paragraph. The denominator 
of this ratio is the amount included in the numerator plus the amounts 
in the shareholders surplus account and policyholders surplus account, 
all determined as of the beginning of the year of the distribution.
    (3) Adjustment for certain distributions. Section 815(e)(2)(B) 
provides that if between 1958 and the year of distribution the taxpayer 
has been treated as having made a distribution (under a plan of 
mutualization or otherwise) which is treated as a return of paid-in 
capital and paid-in surplus or as out of other accounts (as defined in 
Sec. 1.815-5), the aggregate amount of any such prior distributions must 
be subtracted from the numerator and denominator in all cases where the 
allocation ratio provided by subparagraph (2) of this paragraph applies.
    (f) Recomputation required as a result of a subsequent loss from 
operations under section 812--(1) In general. Any amounts added to or 
subtracted from the special surplus accounts referred to in section 
815(a) and paragraph (b) of Sec. 1.815-2 for any taxable year shall be 
adjusted to the extent necessary to properly reflect a subsequent loss 
from operations which under section 812 is carried back to the taxable 
year for which such additions or subtractions were made.
    (2) Example. The application of subparagraph (1) of this paragraph 
may be illustrated by the following example:


[[Page 570]]


    Example. Assume that for the taxable years 1959 through 1961, the 
books of S, a stock life insurance company subject to a 30 percent tax 
rate for all taxable years involved, reflect the following items:

------------------------------------------------------------------------
                                            1959       1960       1961  
------------------------------------------------------------------------
Taxable investment income..............     $40.00     $40.00     $40.00
Gain from operations...................      60.00      60.00      60.00
Tax base (sec. 802(b)(1) and (2))......      50.00      50.00      50.00
Tax (sec. 802(b)(1) and (2) base)......      15.00      15.00      15.00
Shareholders surplus account--                                          
  At beginning of year.................          0      35.00      37.00
  Added at beginning of year by reason                                  
   of election under sec. 815(d)(1)....          0       7.00          0
  Added for year (without regard to                                     
   election under sec. 815(d)(1))......      35.00      35.00      35.00
  Subtracted (distributions)...........          0      40.00      40.00
Policyholders surplus account--                                         
  At beginning of year.................          0          0      10.00
  Added for year.......................      10.00      10.00      10.00
  Subtracted (distributions)...........          0          0          0
  Subtracted (by reason of election                                     
   under sec. 815(d)(1))...............      10.00          0          0
  Tax base (sec. 802(b)(3))............      10.00          0          0
  Tax (sec. 802(b)(3) base)............       3.00          0          0
------------------------------------------------------------------------

Assume further that S has a loss from operations for the taxable year 
1962 of $25. Under the provisions of section 812, the $25 loss from 
operations would be carried back to the taxable year 1959 and would 
reduce the 1959 tax base under section 802(b)(1) and (2) to $35 ($60 
minus $25). After adjustments reflecting the 1962 loss from operations, 
the results for the taxable years 1959 through the beginning of 1962 
would be as follows:

------------------------------------------------------------------------
                                        1959     1960     1961     1962 
------------------------------------------------------------------------
Taxable investment income...........   $40.00   $40.00   $40.00  .......
Gain from operations................    35.00    60.00    60.00  .......
Tax base (sec. 802(b)(1) and (2))...    35.00    50.00    50.00  .......
Tax (sec. 802(b)(1) and (2) base)...    10.50    15.00    15.00  .......
Shareholders surplus account--                                          
  At beginning of year..............        0    24.50    19.50   $14.50
  Added for year (without regard to                                     
   election under sec. 815(d)(1))...    24.50    35.00    35.00  .......
  Added by reason of election under                                     
   sec. 815(d)(1)...................        0        0        0  .......
  Subtracted (distributions)........        0    40.00    40.00  .......
Policyholders surplus account--                                         
  At beginning of year..............        0        0    10.00    20.00
  Added for year....................        0    10.00    10.00  .......
  Subtracted (distributions)........        0        0        0  .......
  Subtracted (by reason of election                                     
   under sec. 815(d)(1))............        0        0        0  .......
Tax base (sec. 802(b)(3))...........        0        0        0  .......
Tax (sec. 802(b)(3) base)...........        0        0        0  .......
------------------------------------------------------------------------

As a result of the loss from operations for 1962, the election under 
section 815(d)(1) for the taxable year 1959 has become inapplicable in 
its entirety since the balance in the policyholders surplus account at 
the end of 1959, as recomputed, is zero. Thus, S would be entitled to a 
total refund of $7.50 for the taxable year 1959. Of this amount, $4.50 
is due to the recomputation of the section 802(b)(1) and (2) tax base 
and $3 to the amount of tax paid by reason of the election under section 
815(d)(1).

[T.D. 6535, 26 FR 545, Jan. 20, 1961]

                        Miscellaneous Provisions



Sec. 1.817-1   Taxable years affected.

    Except as otherwise provided therein, Secs. 1.817-2 through 1.817-4 
are applicable only to taxable years beginning after December 31, 1957, 
and all references to sections of part I, subchapter L, chapter 1 of the 
Code are to the Internal Revenue Code of 1954, as amended by the Life 
Insurance Company Income Tax Act of 1959 (73 Stat. 112) and section 3 of 
the Act of October 23, 1962 (76 Stat. 1134).

[T.D. 6886, 31 FR 8689, June 23, 1966]



Sec. 1.817-2   Treatment of capital gains and losses.

    (a) In general. For taxable years beginning after December 31, 1958, 
and before January 1, 1962, if the net long-term capital gain (as 
defined in section 1222(7)) of any life insurance company exceeds its 
net short-term capital loss (as defined in section 1222(6)), section 
802(a)(2) prior to its amendment by section 3 of the Act of October 23, 
1962 (76 Stat. 1134), imposes a separate tax equal to 25 percent of such 
excess. For taxable years beginning after December 31, 1961, if the net 
long-term capital

[[Page 571]]

gain of any life insurance company exceeds its net short-term capital 
loss, section 802(a)(2) imposes an alternative tax in lieu of the tax 
imposed by section 802(a)(1), if and only if such alternative tax is 
less than the tax imposed by section 802(a)(1). Except as modified by 
section 817 (rules relating to certain gains and losses), the general 
rules of the Code relating to gains and losses, such as subchapter O 
(relating to gain or loss on disposition of property), subchapter P 
(relating to capital gains and losses), etc., shall apply with respect 
to life insurance companies.
    (b) Modification of section 1221 and 1231. (1) In the case of a life 
insurance company, section 817(a)(1) provides that for purposes of 
applying section 1231(a) (relating to property used in the trade or 
business and involuntary conversions), the term property used in the 
trade or business shall be treated as including only:
    (i) Property used in carrying on an insurance business, of a 
character subject to the allowance for depreciation under section 167 
(even though fully depreciated), held for more than 1 year (6 months for 
taxable years beginning before 1977; 9 months taxable years beginning in 
1977), and real property used in carrying on an insurance business, held 
for more than 1 year (6 months for taxable years beginning before 1977; 
9 months taxable years beginning in 1977), and which is not:
    (a) Property of a kind which would properly be includible in the 
inventory of the taxpayer if on hand at the close of the taxable year;
    (b) Property held by the taxpayer primarily for sale to customers in 
the ordinary course of business; or
    (c) A copyright, a literary, musical, or artistic composition, a 
letter or memorandum, or similar property held by a taxpayer described 
in section 1221(3). In the case of a letter, memorandum, or property 
similar to a letter or memorandum, this subdivision (c) applies only to 
sales and other dispositions occurring after July 25, 1969.
    (ii) The cutting or disposal of timber, or the disposal of coal or 
iron ore, to the extent considered arising from a sale or exchange by 
reason of the provisions of section 631 and the regulations thereunder.
    (2) In the case of a life insurance company, section 817(a)(2) 
provides that for purposes of applying section 1221(2) (relating to the 
exclusion of certain property from the term capital asset), the 
reference to property used in trade or business shall be treated as 
including only property used in carrying on an insurance business.
    (3) Section 1231(a), as modified by section 817(a)(1) and 
subparagraph (1) of this paragraph, shall apply to recognized gains and 
losses from the following:
    (i) The sale, exchange, or involuntary conversion of the following 
property, if held for more than 1 year (6 months for taxable years 
beginning before 1977; 9 months taxable years beginning in 1977):
    (a) The home office and branch office buildings (including land) 
owned and occupied by the life insurance company;
    (b) Furniture and equipment owned by the life insurance company and 
used in the home office and branch office buildings occupied by the life 
insurance company; and
    (c) Automobiles and other depreciable personal property used in 
connection with the operations conducted in the home office and branch 
office buildings occupied by the life insurance company.
    (ii) The involuntary conversion of capital assets held for more than 
1 year (6 months for taxable years beginning before 1977; 9 months 
taxable years beginning in 1977).
    (iii) The cutting or disposal of timber, or the disposal of coal or 
iron ore, to the extent considered arising from a sale or exchange by 
reason of the provisions of section 631 and the regulations thereunder.
    (4) Section 1221(2), as modified by section 817(a)(2) and 
subparagraph (2) of this paragraph, shall include only the following 
property;
    (i) The home office and branch office buildings (including land) 
owned and occupied by the life insurance company;
    (ii) Furniture and equipment owned by the life insurance company and 
used in the home office and branch office buildings occupied by the life 
insurance company; and

[[Page 572]]

    (iii) Automobiles and other depreciable personal property used in 
connection with the operations conducted in the home office and branch 
office buildings occupied by the life insurance company.
    (5) If an asset described in subparagraph (3) (i)(a), (b), or (c) or 
subparagraph (4) of this paragraph, or any portion thereof, is also an 
``investment asset'' (an asset from which gross investment income, as 
defined in section 804(b), is derived), such asset, or portion thereof, 
shall not be treated as an asset used in carrying on an insurance 
business. Accordingly, the gains or losses from the sale or exchange (or 
considered as from the sale or exchange) of depreciable assets 
attributable to any trade or business, other than the insurance trade or 
business, carried on by the life insurance company, such as operating a 
radio station, housing development, or a farm, or renting various pieces 
of real estate shall be treated as gains or losses from the sale or 
exchange of a capital asset unless such asset is involuntarily converted 
(within the meaning of paragraph (e) of Sec. 1.123-1).
    (c) Illustration of principles. The provisions of section 817(a) and 
this section may be illustrated by the following examples:

    Example 1. L, a life insurance company, has recognized gains and 
losses for the taxable year 1959 from the sale or involuntary conversion 
of the following items:

------------------------------------------------------------------------
                                                     Gains      Losses  
------------------------------------------------------------------------
Stocks, held for more than 6 months.............    $100,000  ..........
Bonds, held for more than 6 months..............  ..........      $5,000
Housing development, held for more than 6 months  ..........     400,000
Branch office building owned and occupied by L,                         
 held for more than 6 months....................  ..........     115,000
Furniture and equipment used in the investment                          
 department, held for more than 6 months........      30,000  ..........
Radio station, held for more than 6 months......     200,000  ..........
Involuntary conversion of apartment building,                           
 held for more than 6 months....................       7,000  ..........
------------------------------------------------------------------------

The recognized gains and losses from the sale of the stocks, bonds, 
housing development, and radio station shall be treated as gains and 
losses from the sale of capital assets since such items are capital 
assets within the meaning of section 1221 (as modified by section 
817(a)(2)). Accordingly, the provisions of section 1231 shall not apply 
to the sale of such capital assets. However, the provisions of section 
1231 (as modified by section 817(a)(1)) shall apply to the sale of the 
branch office building and the furniture and equipment, and the 
apartment building involuntarily converted. Since the aggregate of the 
recognized losses ($115,000) exceeds the aggregate of the recognized 
gains ($37,000), the gains and losses are treated as ordinary gains and 
losses.
    Example 2. Y, a life insurance company, owns a twenty-story home 
office building, having an adjusted basis of $15,000,000, ten floors of 
which it rents to various tenants, one floor of which is utilized by it 
in operating its investment department, and the remaining nine floors of 
which are occupied by it in carrying on its insurance business. If in 
1960, Y sells the building for $10,000,000, Y must first apportion its 
basis between that portion of the building (one-half) used in carrying 
on an insurance business, and that portion of the building (one-half) 
classified as an ``investment asset'', before it can determine the 
character of the loss attributable to each portion of the building. For 
such purpose, the one floor utilized by Y in operating its investment 
department is treated as used in carrying on an insurance business. 
Assuming that each portion of the building bears an equal (one-half) 
relation to the basis of the entire building, Y (without regard to 
section 817(b)) would have a $2,500,000 ordinary loss on that portion 
used in carrying on an insurance business (assuming that Y had no gains 
subject to section 1231), and a $2,500,000 capital loss on that portion 
of the building classified as an investment asset.

[T.D. 6558, 26 FR 2782, Apr. 4, 1961, as amended by T.D. 6841, 30 FR 
9308, July 27, 1965; T.D. 6886, 31 FR 8689, June 23, 1966; T.D. 7369, 40 
FR 29840, July 16, 1975; T.D. 7728, 45 FR 72650, Nov. 3, 1980]



Sec. 1.817-3   Gain on property held on December 31, 1958, and certain substituted property acquired after 1958.

    (a) Limitation on gain recognized on property held on December 31, 
1958. (1) Section 817(b)(1) limits the amount of gain that shall be 
recognized on the sale or other disposition of property other than 
insurance and annuity contracts (and contracts supplementary

[[Page 573]]

thereto) and property described in section 1221(1) (relating to stock in 
trade or inventory-type property) if:
    (i) The property was held (or treated as held within the meaning of 
paragraph (c)(1) of this section) by a life insurance company on 
December 31, 1958;
    (ii) The taxpayer has been a life insurance company at all times on 
and after December 31, 1958, including the date of the sale or other 
disposition of the property; and
    (iii) The fair market value of the property on December 31, 1958, 
exceeds the adjusted basis for determining gain as of such date.

The gain on the sale or other disposition of such property shall be 
limited to an amount (but not less than zero) equal to the amount by 
which the gain (determined without regard to section 817(b)(1)) exceeds 
the difference between fair market value of such property on December 
31, 1958, and the adjusted basis for determining gain as of such date. 
Accordingly, the tax imposed under section 802(a) shall apply with 
respect to the amount of gain so limited. In addition, in the case of a 
stock life insurance company, the amount of such gain shall be taken 
into account under section 815(b)(2)(A)(ii) for purposes of determining 
the amount to be added to the shareholders surplus account (as defined 
in section 815(b) and Sec. 1.815-3) for the taxable year. Furthermore, 
the amount of the gain (determined without regard to section 817(b)(1) 
and this paragraph) which is not taken into account under section 802(a) 
and under paragraph (f) of Sec. 1.802-3 by reason of the application of 
section 817(b)(1) shall be included in other accounts (as defined in 
Sec. 1.815-5) by such a company for the taxable year.
    (2) Section 817(b)(1) and subparagraph (1) of this paragraph shall 
not apply for purposes of determining loss with respect to property held 
on December 31, 1958.
    (b) Illustration of principles. The application of section 817(b)(1) 
and paragraph (a) of this section may be illustrated by the following 
examples:

    Example 1. On December 31, 1958, J, a stock life insurance company, 
owned stock of Z Corporation and on such date the stock had an adjusted 
basis for determining gain of $5,000 and a fair market value of $6,000. 
On August 1, 1959, the company sells such stock for $8,000. Assuming J 
qualifies as a life insurance company for the taxable year 1959, and 
applying the provisions of section 817(b)(1) and paragraph (a) of this 
section, the gain recognized (assuming no adjustment to basis for the 
period since December 31, 1958) on the sale shall be limited to $2,000 
(the amount by which the gain realized, $3,000, exceeds the difference, 
$1,000, between the fair market value, $6,000, and the adjusted basis, 
$5,000, for determining gain on December 31, 1958). Thus, J shall take 
into account $2,000 under section 815(b)(2)(A)(ii) for purposes of 
determining the amount to be added to its shareholders surplus account 
for the taxable year and shall include $1,000 in other accounts for the 
taxable year.
    Example 2. The facts are the same as in example 1, except that the 
selling price is $5,800. In such case, no gain shall be recognized even 
though there is a realized gain of $800 since such realized gain does 
not exceed the difference ($1,000) between the fair market value 
($6,000) and the adjusted basis ($5,000) for determining gain on 
December 31, 1958. Furthermore, no loss shall be realized or recognized 
as a result of this transaction. Thus, J shall include $800 in other 
accounts for the taxable year and shall not take into account any amount 
under section 815(b)(2)(A)(ii).
    Example 3. The facts are the same as in example 1, except that the 
adjusted basis for determining loss is $5,000 and the selling price is 
$4,500. In such case, since J has sustained a loss, section 817(b)(1) 
does not apply.

    (c) Certain substituted property acquired after December 31, 1958. 
Section 817(b)(2) provides that if a life insurance company acquires 
property after December 31, 1958, in exchange for property actually held 
by the company on December 31, 1958, and the property acquired has a 
substituted basis within the meaning of section 1016(b) and Sec. 1.1016-
10, the following rules shall apply:
    (1) For purposes of section 817(b)(1), such acquired property shall 
be deemed as having been held continuously by the taxpayer since the 
beginning of the holding period thereof as determined under section 
1223;
    (2) The fair market value and adjusted basis referred to in section 
817(b)(1) shall be that of that property for which the holding period 
taken into account includes December 31, 1958;

[[Page 574]]

    (3) Section 817(b)(1) shall apply only if the property or 
properties, the holding periods of which are taken into account, were 
held only by life insurance companies after December 31, 1958, during 
the holding periods so taken into account;
    (4) The difference between the fair market value and adjusted basis 
referred to in section 817(b)(1) shall be reduced (but not below zero) 
by the excess of (i) the gain that would have been recognized but for 
section 817(b) on all prior sales or other dispositions after December 
31, 1958, of properties referred to in section 817(b)(2)(C) over (ii) 
the gain that was recognized on such sales or other dispositions; and
    (5) The basis of such acquired property shall be determined as if 
the gain which would have been recognized but for section 817(b) were 
recognized gain.

For purposes of section 817(b)(2) and this paragraph, the term property 
does not include insurance and annuity contracts (and contracts 
supplementary thereto) and property described in section 1221(1) 
(relating to stock in trade or inventory-type property). Furthermore, 
the provisions of section 817(b)(1) and paragraph (a)(1) of this section 
shall not apply for purposes of determining loss with respect to 
property described in section 817(b)(2) and this paragraph.
    (d) Illustration of principles. The application of section 817(b)(2) 
and paragraph (c) of this section may be illustrated by the following 
example:

    Example. Assume that W, a life insurance company, owns property B on 
December 31, 1958, at which time its adjusted basis was $1,000 and its 
fair market value was $1,800. On January 31, 1960, in a transaction to 
which section 1031 (relating to exchange of property held for productive 
use or investment) applies, W receives property H having a fair market 
value of $1,700 plus $300 in cash in exchange for property B. The gain 
realized on the transaction, without regard to section 817(b) is $1,000 
(assuming no adjustments to basis for the period since December 31, 
1958). Under the provisions of section 817(b)(1) the gain is limited to 
$200. The entire $200 shall be recognized since such amount is less than 
the amount of gain ($300) which would be recognized under section 1031. 
Applying the provisions of section 817(b)(2) and paragraph (c) of this 
section, the basis of property H shall be determined as if the entire 
$300 of cash received is recognized gain. Thus, the basis of property H 
under section 1031 is $1,000 ($1,000 (the basis of property B) minus 
$300 (the amount of money received) plus $300 (the recognized gain of 
$200 plus $100 which would have been recognized but for section 817(b)). 
If W later sells property H for $2,200 cash, and assuming no further 
adjustments to its basis of $1,000, the gain realized is $1,200, but due 
to the application of section 817(b)(2) the amount of gain recognized is 
$500, computed as follows:

Selling price...............................................      $2,200
Less: Adjusted basis as of date of sale.....................       1,000
                                                 -------------          
    Gain realized...........................................       1,200
Fair market value as of 12-31-58................      $1,800            
Adjusted basis as of 12-31-58...................       1,000            
                                                 ------------           
  Excess of fair market value over adjusted                             
   basis........................................         800            
Less: Excess of gain which would have been                              
 recognized on all prior dispositions but for                           
 sec. 817(b) over gain recognized on all prior                          
 dispositions ($300 minus $200).................         100            
                                                   ---------        $700
    Gain recognized.............................         500            
                                                                        

[T.D. 6558, 26 FR 2783, Apr. 4, 1961, as amended by T.D. 6886, 31 FR 
8689, June 23, 1966]



Sec. 1.817-4   Special rules.

    (a) Limitation on capital loss carryovers. Section 817(c) provides 
that a net capital loss (as defined in section 1222(10)) for any taxable 
year beginning before January 1, 1959, shall not be taken into account. 
For any taxable year beginning after December 31, 1958, the provisions 
of part II, subchapter P, chapter 1 of the Code (relating to the 
treatment of capital losses) shall be applicable to life insurance 
companies for purposes of determining the tax imposed by section 802(a) 
and Sec. 1.802-3 (relating to the imposition of tax in case of capital 
gains).
    (b) Gain on transactions occurring prior to January 1, 1959. For 
purposes of part I, subchapter L, chapter 1 of the Code, section 817(d) 
provides that:
    (1) There shall be excluded from tax any gain from the sale or 
exchange of a capital asset, and any gain considered as gain from sale 
or exchange of a capital asset, which results from sales or other 
dispositions of property prior to January 1, 1959; and
    (2) Any gain after December 31, 1958, resulting from the sale or 
other disposition of property prior to January 1, 1959, which, but for 
this subparagraph

[[Page 575]]

would be taken into account under section 1231, shall not be taken into 
account under section 1231.

For example, if a life insurance company makes an installment sale of a 
capital asset prior to January 1, 1959, and payments are received after 
such date, any capital gain attributable to such sale shall not be taken 
into account for purposes of section 802(a). Furthermore, any gain 
referred to in subparagraphs (1) and (2) and the preceding sentence 
shall not be taken into account in determining the excess of the net 
short-term capital gain over the net long-term capital loss (and for 
taxable years beginning after December 31, 1961, the excess of the net 
long-term capital gain over the net short-term capital loss) for 
purposes of computing taxable investment income under section 804(a)(2) 
or gain or loss from operations under section 809(b).
    (c) Certain reinsurance transactions in 1958. For purposes of part 
I, section 817(e) provides that where a life insurance company reinsures 
(or sells) all of its insurance contracts of a particular type, such as 
an entire industrial department, in either a single transaction, or in a 
series of related transactions, all of which occurred during 1958, and 
the reinsuring (or purchasing) company or companies assume all 
liabilities under such contracts, such reinsurance (or sale) shall be 
treated as the sale of a capital asset. However, such transaction shall 
be subject to the provisions of section 806(a) and Sec. 1.806-3 
(relating to adjustments for certain changes in reserves and assets).
    (d) Certain other reinsurance transactions. (1) For any taxable year 
beginning after December 31, 1958, the reinsurance of all or a part of 
the insurance contracts of a particular type by a life insurance 
company, in either a single transaction, or in a series of related 
transactions, occurring in any such taxable year, whereby the reinsuring 
company or companies assume all liabilities under such contracts, shall 
not be treated as the sale or exchange of a capital asset but shall be 
subject to the provisions of section 806(a) and 809 and the regulations 
thereunder. However, if in connection with a transaction described in 
the preceding sentence the reinsured or reinsurer transfers an asset 
which is a capital asset within the meaning of section 1221 (as modified 
by section 817(a)(2)), such transfer shall be treated as the sale or 
exchange of a capital asset by the transferor.
    (2)(i) The consideration paid by the reinsured to the reinsurer in 
connection with a transaction described in subparagraph (1) of this 
paragraph shall be treated as an item of deduction under section 
809(d)(7). However any amount received by the reinsured from the 
reinsurer shall be applied against and reduce (but not below zero) the 
amount of such consideration, and to the extent that it exceeds such 
consideration, shall be treated as an item of gross amount under section 
809(c)(3).
    (ii) In connection with an assumption reinsurance (as defined in 
paragraph (a)(7)(ii) of Sec. 1.809-5) transaction, a reinsurer shall in 
any taxable year beginning after December 31, 1957:
    (A) Treat the consideration received from the reinsured in any such 
taxable year as an item of gross amount under section 809(c)(1), and
    (B) Treat any amount paid to the reinsured for the purchase of such 
contracts, to the extent such amount meets the requirements of section 
162, as a deferred expense that may be amortized over the reasonably 
estimated life (as defined in paragraph (d)(2)(iv) of this section) of 
the contracts reinsured and treat the portion of the expense so 
amortized in each taxable year as a deduction under section 809(d)(12) 
irrespective of the taxable year in which such amount was paid to the 
reinsured.
    (iii) For purposes of paragraph (d)(2)(ii) of this section where the 
reinsured transfers to the reinsurer in connection with the assumption 
reinsurance transaction a net amount which is less than the increase in 
the reinsurer's reserves resulting from the transaction, the reinsurer 
shall be treated as:
    (A) Having received from the reinsured consideration in an amount 
equal to the net amount of the increase in the reinsurer's reserves 
resulting from the transaction, and
    (B) Having paid the reinsured an amount for the purchase of the 
contracts equal to the excess of the

[[Page 576]]

amount of such increase in the reinsurer's reserves over the net amount 
received from the reinsured.
    (iv) For purposes of this subparagraph, the term reasonably 
estimated life means the period during which the contract reinsured 
remains in force. Such period shall be based on the facts in each case 
(such as age, health, and sex of the insured, type of contract 
reinsured, etc.) and the assuming company's experience (such as 
mortality, lapse rate, etc.) with similar risks.
    (3) The provisions of this paragraph may be illustrated by the 
following examples:

    Example 1. On June 30, 1959, X, a life insurance company, reinsured 
a portion of its insurance contracts with Y, a life insurance company, 
under an agreement whereby Y agreed to assume and to become solely 
liable under the contracts reinsured. The reserves on the contracts 
reinsured by X were $100,000. Under the reinsurance agreement X agreed 
to pay Y $100,000 for assuming such contracts and Y agreed to pay X 
$17,000 for the right to receive future premium payments under this 
block of contracts. Rather than exchange payments of money, X agreed to 
pay Y a net amount of $83,000 in cash. Assuming that the reasonably 
estimated life of the contracts reinsured is 17 years, that there are no 
other insurance transactions by X or Y during the taxable year, and 
assuming that X and Y compute the reserves on the contracts reinsured on 
the same basis, X has income of $100,000 under section 809(c)(2) as a 
result of the net decrease in its reserves. X has a net deduction of 
$83,000 ($100,000-$17,000) under section 809(d)(7). For the taxable year 
1959, Y has income of $100,000 under section 809(c)(1) as a result of 
the consideration received from X and a deduction of $100,000 under 
section 809(d)(2) for the net increase in reserves and $1,000 ($17,000 
divided by 17, the reasonably estimated life of the contracts 
reinsured), under section 809(d)(12). The remaining $16,000 shall be 
amortized over the next 16 succeeding taxable years 
(16 x $1,000=$16,000) under section 809(d)(12) at the rate of $1,000 for 
each such taxable year.
    Example 2. The facts are the same as in example 1, except X agreed 
to pay Y a consideration of $100,000 in cash for assuming these 
contracts and Y paid X a bonus of $17,000 in cash and that this bonus 
meets the requirements of section 162. Assuming that the reasonably 
estimated life of the contracts reinsured is 17 years, X has income of 
$100,000 under section 809(c)(2) as a result of this net decrease in its 
reserves and a deduction of $83,000 under section 809(d)(7) for the 
amount of the consideration ($100,000) paid to Y for assuming these 
contracts, reduced by the bonus ($17,000) received from Y. For the 
taxable year 1959, Y has income of $100,000 under section 809(c)(1) as a 
result of the consideration received from X and deductions of $100,000 
under section 809(d)(2) for the net increase in reserves and $1,000 (the 
bonus of $17,000 divided by 17, the reasonably estimated life of the 
contracts reinsured), under section 809(d)(12). The remaining amount of 
the bonus ($16,000) shall be amortized over the next 16 succeeding 
taxable years (16 x $1,000=$16,000) under section 809(d)(12) at the rate 
of $1,000 for each such taxable year.
    Example 3. The facts are the same as in Example 1, except that the 
reinsurance agreement does not specifically provide that X agreed to pay 
Y $100,000 for assuming the contracts reinsured and Y agreed to pay X 
$17,000 for the right to receive future premium payments under such 
contracts. Instead, X agreed to pay Y a net amount of $83,000 in cash 
for assuming such contracts. Nevertheless, Y is treated as having 
received from X consideration equal to $100,000, the amount of the 
increase in Y's reserves, and as having paid $17,000 ($100,000 less 
$83,000) for the purchase of such contracts. Therefore, for the taxable 
year 1959, Y has income of $100,000 under section 809(c)(1). Y also has 
a deduction of $100,000 under section 809(d)(2) for the net increase in 
its reserves and an amortization deduction under section 809(d)(12) of 
$1,000 ($17,000 divided by 17, the reasonably estimated life of the 
contracts reinsured). The remaining $16,000 shall be amortized by Y over 
the next 16 succeeding years at the rate of $1,000 for each such year. 
For 1959, X has income of $100,000 under section 809(c)(2) as a result 
of the net decrease in its reserves and a deduction of $83,000 under 
section 809(d)(7) for the net amount of consideration paid to Y for 
assuming the contracts reinsured.
    Example 4. The facts are the same as in example 1, except that X 
agreed to pay Y a consideration of $130,000 in cash for assuming such 
contracts. Based upon these facts, X has income of $100,000 under 
section 809(c)(2) as a result of this net decrease in its reserves and a 
deduction of $130,000 under section 809(d)(7) for the amount of the 
consideration paid to Y for assuming these contracts. Y has income of 
$130,000 under section 809(c)(1) as a result of the consideration 
received from X and a deduction of $100,000 under section 809(d)(2) for 
the net increase in its reserves.
    Example 5. On August 1, 1960, R, a life insurance company, reinsured 
all of its insurance policies with S, a life insurance company, under an 
agreement whereby S agreed to assume and become solely liable under the 
contracts reinsured. The reserves on the contracts reinsured by R were 
$3,000,000. Under the reinsurance agreement, R agreed to pay S a 
consideration of $3,000,000 in stocks and

[[Page 577]]

bonds for assuming such contracts. Assuming no other insurance 
transactions by R or S during the taxable year, that R and S compute the 
reserves on the contracts reinsured on the same basis, and that R has a 
recognized gain (after the application of the limitation of section 
817(b)(1)) of $20,000 due to appreciation in value of the assets 
transferred, the results to each company are as follows:

                          Company R (reinsured)                         
Net decrease in reserves (sec. 809(c) (2)).................   $3,000,000
Capital gain (as limited by sec. 817(b) (1)) to be taxed                
 separately under sec. 802(a)(2)...........................       20,000
Consideration paid by R to S in respect of S's assuming                 
 liabilities under contracts issued by R (sec. 809(d)(7))..   $3,000,000
                                 Income                                 
                          Company S (reinsurer)                         
Consideration received by S in respect of assuming                      
 liabilities under contracts issued by R (sec. 809(c)(1))..   $3,000,000
                               Deductions                               
Net increase in reserves (sec.809(d)(2))...................   $3,000,000
                                                                        

[T.D. 6558, 26 FR 2783, Apr. 4, 1961, as amended by T.D. 6625, 27 FR 
12543, Dec. 19, 1962; T.D. 6886, 31 FR 8689, June 23, 1966; T.D. 41 FR 
5100, Feb. 4, 1976]



Sec. 1.817-5  Diversification requirements for variable annuity, endowment, and life insurance contracts.

    (a) Consequences of nondiversification--(1) In general. Except as 
provided in paragraph (a)(2) of this section, for purposes of subchapter 
L, section 72, and section 7702(a), a variable contract (as defined in 
section 817(d)), other than a pension plan contract (as defined in 
section 818(a)), which is based on one or more segregated asset accounts 
shall not be treated as an annuity, endowment, or life insurance 
contract for any calendar quarter period for which the investments of 
any such account are not adequately diversified. For this purpose, a 
variable contract shall be treated as based on a segregated asset 
account for a calendar quarter period if amounts received under the 
contract (or earnings thereon) are allocated to the segregated asset 
account at any time during the period. In addition, a variable contract 
that is not treated as an annuity, endowment, or life insurance contract 
for any period by reason of this paragraph (a)(1) shall not be treated 
as an annuity, endowment, or life insurance contract for any subsequent 
period even if the investments are adequately diversified for such 
subsequent period. If a variable contract which is a life insurance or 
endowment contract under other applicable (e.g., State or foreign) law 
is not treated as a life insurance or endowment contract under section 
7702(a), the income on the contract for any taxable year of the 
policyholder is treated as ordinary income received or accrued by the 
policyholder during such year in accordance with section 7702 (g) and 
(h). Likewise, if a variable contract is not treated as an annuity 
contract under section 72, the income on the contract for any taxable 
year of the policyholder shall be treated as ordinary income received or 
accrued by the policyholder during such year in the same manner as a 
life insurance or endowment contract under section 7702 (g) and (h).
    (2) Inadvertent failure to diversify. The investments of a 
segregated asset account shall be treated as satisfying the requirements 
of paragraph (b) of this section for one or more periods, provided the 
following conditions are satisfied--
    (i) The issuer or holder must show the Commissioner that the failure 
of the investments to satisfy the requirements of paragraph (b) of this 
section for such period or periods was inadvertent,
    (ii) The investments of the account must satisfy the requirements of 
paragraph (b) of this section within a reasonable time after the 
discovery of such failure, and
    (iii) The issuer or holder of the variable contract must agree to 
make such adjustments or pay such amounts as may be required by the 
Commissioner with respect to the period or periods during which the 
investments of the account did not satisfy the requirements of paragraph 
(b) of this section. The amount required by the Commissioner to be paid 
shall be an amount based upon the tax that would have been owed by the 
policyholders if they were treated as receiving the income on the 
contract (as defined in section 7702(g)(1)(B), without regard to section 
7702(g)(1)(C)) for such period or periods.
    (b) Diversification of investments--(1) In general. (i) Except as 
otherwise provided in this paragraph and paragraph (c) of this section, 
the investments of a

[[Page 578]]

segregated asset account shall be considered adequately diversified for 
purposes of this section and section 817(h) only if--
    (A) No more than 55% of the value of the total assets of the account 
is represented by any one investment;
    (B) No more than 70% of the value of the total assets of the account 
is represented by any two investments;
    (C) No more than 80% of the value of the total assets of the account 
is represented by any three investments; and
    (D) No more than 90% of the value of the total assets of the account 
is represented by any four investments.
    (ii) For purposes of this section--
    (A) All securities of the same issuer, all interests in the same 
real property project, and all interests in the same commodity are each 
treated as a single investment; and
    (B) In the case of government securities, each government agency or 
instrumentality shall be treated as a separate issuer.
    (iii) See paragraph (f) of this section for circumstances in which a 
segregated asset account is treated as the owner of assets held 
indirectly through certain pass-through entities and corporations taxed 
under subchapter M, chapter 1 of the Code.
    (2) Safe harbor. A segregated asset account will be considered 
adequately diversified for purposes of this section and section 817(h) 
if--
    (i) The account meets the requirements of section 851 (b)(4) and the 
regulations thereunder; and
    (ii) No more than 55% of the value of the total assets of the 
account is attributable to cash, cash items (including receivables), 
government securities, and securities of other regulated investment 
companies.
    (3) Alternative diversification requirements for variable life 
insurance contracts. (i) A segregated asset account with respect to 
variable life insurance contracts will be considered adequately 
diversified for purposes of this section and section 817(h) if the 
requirements of paragraph (b)(1) or (b)(2) of this section are satisfied 
or if the assets of such account, other than Treasury securities, 
satisfy the percentage limitations prescribed in paragraph (b)(1) of 
this section increased by the product of (A) .5 and (B) the percentage 
of the value of the total assets of the account that is represented by 
Treasury securities. In determining whether the assets of an account, 
other than Treasury securities, satisfy the increased percentage 
limitations, such limitations are applied as if the Treasury securities 
were not included in the account (i.e., the increased percentage 
limitations are not applied to Treasury securities and the value of the 
total assets of the account is reduced by the value of the Treasury 
securities).
    (ii) The provisions of this paragraph (b)(3) may be illustrated by 
the following examples:

    Example 1. On the last day of a quarter of a calendar year, a 
segregated asset account with respect to variable life insurance 
contracts holds assets having a total value of $100,000. The assets of 
the account are represented by Treasury securities having a total value 
of $90,000 and securities of Corporation A having a total value of 
$10,000. The 55% limit described in paragraph (b)(1)(i) of this section 
would be increased by 45% (0.5 x 90%) to 100%, and would then be applied 
to the assets of the account other than Treasury securities. Because no 
more than 100% of the value of the assets other than Treasury securities 
is represented by securities of Corporation A, the investments of the 
account will be considered adequately diversified.
    Example 2. On the last day of a quarter of a calendar year, a 
segregated asset account with respect to variable life insurance 
contracts holds assets having a total value of $100,000. The assets of 
the account are represented by Treasury securities having a total value 
of $60,000, securities of Corporation A having a total value of $30,000, 
and securities of Corporation B having a total value of $10,000. The 55% 
and 70% limits described in paragraph (b)(1)(i) of this section would be 
increased by 30% (0.5 x 60%) to 85% and 100%, respectively, and would 
then be applied to the assets of the account other than Treasury 
securities. Securities of Corporation A represent 75%, and securities of 
Corporation B represent 25%, of the value of the assets of the account 
other than Treasury securities. Because no more than 85% of the value of 
the assets other than Treasury securities is represented by securities 
of Corporation A or B and no more than 100% of the value of the assets 
other than Treasury securities is represented by securities of 
Corporations A and B, the investments of the account will be considered 
adequately diversified.


[[Page 579]]


    (c) Periods for which an account is adequately diversified--(1) In 
general. A segregated asset account that satisfies the requirements of 
paragraph (b) of this section on the last day of a quarter of a calendar 
year (i.e., March 31, June 30, September 30, and December 31) or within 
30 days after such last day shall be considered adequately diversified 
for such quarter.
    (2) Start-up period. (i) Except as provided in paragraph (c)(2)(iv) 
of this section, a segregated asset account that is not a real property 
account on its first anniversary shall be considered adequately 
diversified until such first anniversary.
    (ii) Except as provided in paragraph (c)(2)(iv) of this section, a 
segregated asset account that is a real property account on its first 
anniversary shall be considered adequately diversified until the earlier 
of its fifth anniversary or the anniversary on which the account ceases 
to be a real property account.
    (iii) For purposes of paragraph (c)(2) (i) and (ii) of this section, 
the anniversary of a segregated asset account is the anniversary of the 
date on which any amount received under a life insurance or annuity 
contract, other than a pension plan contract (as defined in section 818 
(a)), is first allocated to the account.
    (iv) If more than 30 percent of the amount allocated to a segregated 
asset account as of the last day of a calendar quarter is attributable 
to contracts entered into more than one year before such date, paragraph 
(c)(2)(i) of this section shall not apply to the segregated asset 
account for any period after such date. Similarly, if more than 30 
percent of the amount allocated to a segregated asset account as of the 
last day of a calendar quarter is attributable to contracts entered into 
more than 5 years before such date, paragraph (c)(2)(ii) of this section 
shall not apply to the segregated asset account for any period after 
such date. For purposes of this paragraph (c)(2), amounts transferred to 
the account from a diversified account (determined without regard to 
this paragraph (c)(2)) or as a result of an exchange pursuant to section 
1035 in which the issuer of the contract received in the exchange is not 
related in a manner specified in section 267(b) to the issuer of the 
contract transferred in the exchange are not treated as--
    (A) Amounts attributable to contracts entered into more than one 
year before such date, in the case of accounts subject to paragraph 
(c)(2)(i) of this section, or
    (B) Amounts attributable to contracts entered into more than five 
years before such date, in the case of accounts subject to paragraph 
(c)(2)(ii) of this section.
    (3) Liquidation period. A segregated asset account that satisfies 
the requirements of paragraph (b) of this section on the date a plan of 
liquidation is adopted shall be considered adequately diversified for--
    (i) The one-year period beginning on the date the plan of 
liquidation is adopted if the account is not a real property account on 
such date; or
    (ii) The two-year period beginning on the date the plan of 
liquidation is adopted if the account is a real property account on such 
date.
    (d) Market fluctuations. A segregated asset account that satisfies 
the requirements of paragraph (b) of this section at the end of any 
calendar quarter (or within 30 days after the end of such calendar 
quarter) shall not be considered nondiversified in a subsequent quarter 
because of a discrepancy between the value of its assets and the 
diversification requirements unless such discrepancy exists immediately 
after the acquisition of any asset and such discrepancy is wholly or 
partly the result of such acquisition.
    (e) Segregated asset account. For purposes of section 817(h) and 
this section, a segregated asset account shall consist of all assets the 
investment return and market value of each of which must be allocated in 
an identical manner to any variable contract invested in any of such 
assets. See paragraph (g) for examples illustrating the application of 
this paragraph (e).
    (f) Look-through rule for assets held through certain investment 
companies, partnerships, or trusts--(1) In general. If this paragraph 
(f) applies, a beneficial interest in a regulated investment company, a 
real estate investment trust, a partnership, or a trust that is

[[Page 580]]

treated under sections 671 through 679 as owned by the grantor or 
another person (``investment company, partnership, or trust'') shall not 
be treated as a single investment of a segregated asset account. 
Instead, a pro rata portion of each asset of the investment company, 
partnership, or trust shall be treated, for purposes of this section, as 
an asset of the segregated asset account. For purposes of this section, 
the ratable interest of a partner in a partnership's assets shall be 
determined in accordance with the partner's capital interest in the 
partnership.
    (2) Applicability--(i) Certain investment companies, partnerships, 
and trusts. This paragraph (f) shall apply to an investment company, 
partnership, or trust if--
    (A) All the beneficial interests in the investment company, 
partnership, or trust (other than those described in paragraph (f)(3) of 
this section) are held by one or more segregated asset accounts of one 
or more insurance companies; and
    (B) Public access to such investment company, partnership, or trust 
is available exclusively (except as otherwise permitted in paragraph 
(f)(3) of this section) through the purchase of a variable contract. 
Solely for this purpose, the status of a contract as a variable contract 
will be determined without regard to section 817(h) and this section.
    (ii) Nonregistered partnerships. This paragraph (f) shall also apply 
to a partnership interest if the partnership interest is not registered 
under a Federal or State law regulating the offering or sale of 
securities.
    (iii) Trusts holding Treasury securities. This paragraph (f) shall 
also apply to a trust that is treated under section 671 through 679 as 
owned by the grantor or another person if substantially all of the 
assets of the trust are represented by Treasury securities.
    (3) Interests not held by segregated asset accounts. Satisfaction of 
the requirements of paragraph (f)(2)(i) of this section shall not be 
prevented by reason of beneficial interests in the investment company, 
partnership, or trust that are--
    (i) Held by the general account of a life insurance company or a 
corporation related in a manner specified in section 267(b) to a life 
insurance company, but only if the return on such interests is computed 
in the same manner as the return on an interest held by a segregated 
asset account is computed (determined without regard to expenses 
attributable to variable contracts), there is no intent to sell such 
interests to the public, and a segregated asset account of such life 
insurance company also holds or will hold a beneficial interest in the 
investment company, partnership, or trust;
    (ii) Held by the manager, or a corporation related in a manner 
specified in section 267(b) to the manager, of the investment company, 
partnership, or trust, but only if the holding of the interests is in 
connection with the creation or management of the investment company, 
partnership, or trust, the return on such interest is computed in the 
same manner as the return on an interest held by a segregated asset 
account is computed (determined without regard to expenses attributable 
to variable contracts), and there is no intent to sell such interests to 
the public;
    (iii) Held by the trustee of a qualified pension or retirement plan; 
or
    (iv) Held by the public, or treated as owned by policyholders 
pursuant to Rev. Rul. 81-225, 1981-2 C.B. 12, but only if (A) the 
investment company, partnership, or trust was closed to the public in 
accordance with Rev. Rul. 82-55, 1982-1 C.B. 12, or (B) all the assets 
of the segregated asset account are attributable to premium payments 
made by policyholders prior to September 26, 1981, to premium payments 
made in connection with a qualified pension or retirement plan, or to 
any combination of such premium payments.
    (g) Examples. The provisions of paragraphs (e) and (f) of this 
section may be illustrated by the following examples.

    Example 1. (i) The assets underlying variable contracts issued by a 
life insurance company consist of two groups of assets: (a) a 
diversified portfolio of debt securities and (b) interests in P, a 
partnership that is publicly registered. All of the beneficial interests 
in P are held by one or more segregated asset accounts of one or more 
insurance companies and public access to P is available exclusively 
through the purchase of a variable contract. The variable contracts 
provide

[[Page 581]]

that policyholders may specify which portion of each premium is to be 
invested in the debt securities and which portion is to be invested in P 
interests. The portfolio of debt securities and the assets of P, 
considered separately, each satisfy the diversification requirements of 
paragraph (b) of this section.
    (ii) As a result of the ability of policyholders to allocate 
premiums among the two groups of assets, the investment return and 
market value of the interests in P and the debt securities may be 
allocated to different variable contracts in a non-identical manner. 
Accordingly, under paragraph (e) of this section, the interests in P are 
treated as part of a single segregated asset account (``Account 1'') and 
the debt securities are treated as part of a different segregated asset 
account (``Account 2'').
    (iii) Since P is described in paragraph (f)(2)(i) of this section, 
interests in P will not be treated as a single investment of Account 1. 
Rather, Account 1 is treated as owning a pro rata portion of the assets 
of P.
    (iv) Since Account 1 and Account 2 each satisfy the requirements of 
paragraph (b) of this section, variable contracts that are based on 
either or both accounts are treated as annuity, endowment, or life 
insurance contracts.
    Example 2. The facts are the same as in example 1 except that some 
of the beneficial interests in P are held by persons not described in 
paragraph (f)(3) of this section. Since P is not described in paragraph 
(f)(2) of this section, interests in P will be treated as a single 
investment of Account 1. As a result, Account 1 does not satisfy the 
requirements of paragraph (b) of this section. Variable contracts based 
in whole or in part on Account 1 are not treated as annuity, endowment, 
or life insurance contracts. Variable contracts that are not based on 
Account 1 at any time during the period in which such account fails to 
satisfy the requirements of paragraph (b) of this section (i.e., 
contracts based entirely on Account 2), are treated as annuity, 
endowment, or life insurance contracts. See paragraph (a)(1).
    Example 3. The facts are the same as in example 2 except that P is 
not publicly registered. Since P is described in paragraph (e)(2)(ii) of 
this section, the result is the same as in example 1.
    Example 4. The facts are the same as in example 2 except that the 
variable contracts do not permit policyholders to allocate premiums 
between or among the debt securities and interests in P. Thus, the 
investment return and market value of the interests in P and the debt 
securities must be allocated to the same variable contracts and in an 
identical manner. Under paragraph (e) of this section, the interests in 
P and the debt securities are treated as part of a single segregated 
asset account. If the interests in P and the debt securities, considered 
together, satisfy the requirements of paragraph (b) of this section, 
contracts based on this segregated asset account will be treated as 
annuity, endowment, or life insurance contracts.

    (h) Definitions. The terms defined below shall, for purposes of this 
section, have the meanings set forth in such definitions:
    (1) Government security--(i) General rule. The term government 
security shall mean any security issued or guaranteed or insured by the 
United States or an instrumentality of the United States; or any 
certificate of deposit for any of the foregoing. Any security or 
certificate or deposit insured or guaranteed only in part by the United 
States or an instrumentality thereof is treated as issued by the United 
States or its instrumentality only to the extent so insured or 
guaranteed, and as issued by the direct obligor to the extent not so 
insured or guaranteed. For purposes of this paragraph (h)(1), an 
instrumentality of the United States shall mean any person that is 
treated for purposes of 15 U.S.C. 80a-2 (16), as amended, as a person 
controlled or supervised by and acting as an instrumentality of the 
Government of the United States pursuant to authority granted by the 
Congress of the United States.
    (ii) Example. A segregated asset account purchases a certificate of 
deposit in the amount of $150,000 from bank A. Deposits in bank A are 
insured by the Federal Deposit Insurance Corporation, an instrumentality 
of the United States, to the extent of $100,000 per depositor. The 
certificate of deposit is treated as a government security to the extent 
of the $100,000 insured amount and is treated as a security issued by 
bank A to the extent of the $50,000 excess of the value of the 
certificate of deposit over the insured amount.
    (2) Treasury security--(i) General rule. For purposes of paragraph 
(b)(3) of this section and section 817(h)(3), the term Treasury security 
shall mean a security the direct obligor of which is the United States 
Treasury.
    (ii) Example. A segregated asset account purchases put and call 
options on U.S. Treasury securities issued by the Options Clearing 
Corporation. The

[[Page 582]]

options are not Treasury securities for purposes of paragraph (b)(3) and 
section 817(h)(3) because the direct obligor of the options is not the 
United States Treasury.
    (3) Real property. The term real property shall mean any property 
that is treated as real property under 1.856-3 (d) except that it shall 
not include interests in real property.
    (4) Real property account. A segregated asset account is a real 
property account on an anniversary of the account (within the meaning of 
paragraph (c)(2)(iii) of this section) or on the date a plan of 
liquidation is adopted if not less than the applicable percentage of the 
total assets of the account is represented by real property or interests 
in real property on such anniversary or date. For this purpose, the 
applicable percentage is 40% for the period ending on the first 
anniversary of the date on which premium income is first received, 50% 
for the year ending on the second anniversary, 60% for the year ending 
on the third anniversary, 70% for the year ending on the fourth 
anniversary, and 80% thereafter. A segregated asset account will also be 
treated as a real property account on its first anniversary if on or 
before such first anniversary the issuer has stated in the contract or 
prospectus or in a submission to a regulatory agency, an intention that 
the assets of the account will be primarily invested in real property or 
interests in real property, provided that at least 40% of the total 
assets of the account are so invested within six months after such first 
anniversary.
    (5) Commodity. The term commodity shall mean any type of personal 
property other than a security.
    (6) Security. The term security shall include a cash item and any 
partnership interest registered under a Federal or State law regulating 
the offering or sale of securities. The term shall not include any other 
partnership interest, any interest in real property, or any interest in 
a commodity.
    (7) Interest in real property. The term interest in real property 
shall include the ownership and co-ownership of land or improvements 
thereon and leaseholds of land or improvements thereon. Such term shall 
not, however, include mineral, oil, or gas royalty interests, such as a 
retained economic interest in coal or iron ore with respect to which the 
special provisions of section 631(c) apply. The term ``interest in real 
property'' also shall include options to acquire land or improvements 
thereon, and options to acquire leaseholds of land or improvements 
thereon.
    (8) Interest in a commodity. The term interest in a commodity shall 
include the ownership and co-ownership of any type of personal property 
other than a security, and any leaseholds thereof. Such term shall 
include mineral, oil, and gas royalty interests, including any 
fractional undivided interest therein. Such term also shall include any 
put, call, straddle, option, or privilege on any type of personal 
property other than a security.
    (9) Value. The term value shall mean, with respect to investments 
for which market quotations are readily available, the market value of 
such investments; and with respect to other investments, fair value as 
determined in good faith by the managers of the segregated asset 
account.
    (10) Terms used in section 851. To the extent not inconsistent with 
this paragraph (h) all terms used in this section shall have the same 
meaning as when used in section 851.
    (i) Effective date--(1) In general. This section is effective for 
taxable years beginning after December 31, 1983.
    (2) Exceptions. (i) If, at all times after December 31, 1983, an 
insurance company would be considered the owner of the assets of a 
segregated asset account under the principles of Rev. Rul. 81-225, 1981-
2 C.B. 12, this section will not apply to such account until December 
15, 1986.
    (ii) This section will not apply to any variable contract to which 
Rev. Rul. 77-85, 1977-1 C.B. 12, or Rev. Rul. 81-225, 1981-2 C.B. 12, 
did not apply by reason of the limited retroactive effect of such 
rulings.
    (iii) In determining whether a segregated asset account is 
adequately diversified for any calendar quarter ending before July 1, 
1988, debt instruments that are issued, guaranteed, or insured by the 
United States or an instrumentality of the United States

[[Page 583]]

shall not be treated as government securities if such debt instruments 
are secured by a mortgage on real property (other than real property 
owned by the United States or an instrumentality of the United States) 
or represent an interest in a pool of debt instruments secured by such 
mortgages.
    (iv) This section shall not apply until January 1, 1989, with 
respect to a variable contract (as defined in section 817(d)) that (1) 
provides for the payment of an immediate annuity (as defined in section 
72(u)(4)); (2) was outstanding on September 12, 1986; and (3) the 
segregated asset account on which it was based was, on September 12, 
1986, wholly invested in deposits insured by the Federal Deposit 
Insurance Corporation or the Federal Savings and Loan Insurance 
Corporation.

[T.D. 8242, 54 FR 8730, Mar. 2, 1989; T.D. 8242, 54 FR 11866, Mar. 22, 
1989]



Sec. 1.818-1   Taxable years affected.

    Sections 1.818-2 through 1.818-8, except as otherwise provided 
therein, are applicable only to taxable years beginning after December 
31, 1957, and all references to sections of part I, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6558, 26 FR 2785, Apr. 4, 1961 as amended by T.D. 7469, 42 FR 
12181, Mar. 3, 1977]



Sec. 1.818-2   Accounting provisions.

    (a) Method of accounting. (1) Section 818(a)(1) provides the general 
rule that all computations entering into the determination of taxes 
imposed by part I, subchapter L, chapter 1 of the Code, shall be made 
under an accrual method of accounting. Thus, the over-all method of 
accounting for life insurance companies shall be the accrual method. 
Except as otherwise provided in part I, the term ``accrual method'' 
shall have the same meaning and application in section 818 as it does 
under section 446 (relating to general rule for methods of accounting) 
and the regulations thereunder. For general rules relating to the 
taxable year for inclusion of income and deduction of expenses under an 
accrual method of accounting, see sections 451 and 461 and the 
regulations thereunder.
    (2) Section 818(a)(2) provides that, to the extent permitted under 
this section, a life insurance company's method of accounting may be a 
combination of the accrual method with any other method of accounting 
permitted by chapter 1 of the Internal Revenue Code of 1954, other than 
the cash receipts and disbursements method. Thus, section 818(a)(2) 
specifically prohibits the use by a life insurance company of the cash 
receipts and disbursements method either separately or in combination 
with a permissible method of accounting. The term ``method of 
accounting'' includes not only the over-all method of accounting of the 
taxpayer but also the accounting treatment of any item. For purposes of 
section 818(a)(2), a life insurance company may elect to compute its 
taxable income under an over-all method of accounting consisting of the 
accrual method combined with the special methods of accounting for 
particular items of income and expense provided under other sections of 
chapter 1 of the Internal Revenue Code of 1954, other than the cash 
receipts and disbursements method. These methods of accounting for 
special items include the accounting treatment provided for depreciation 
(section 167), research and experimental expenditures (section 174), 
soil and water conservation expenditures (section 175), organizational 
expenditures (section 248), etc. In addition, a life insurance company 
may, where applicable, use the crop method of accounting (as provided in 
the regulations under sections 61 and 162), and the installment method 
of accounting for sales of realty and casual sales of personalty (as 
provided in section 453(b)). To the extent not inconsistent with the 
provisions of the Internal Revenue Code of 1954 or the regulations 
thereunder and the method of accounting adopted by the taxpayer pursuant 
to this section, all computations entering into the determination of 
taxes imposed by part I shall be made in a manner consistent with the 
manner required for purposes of the annual statement approved by the 
National Association of Insurance Commissioners.
    (3)(i) An election to use any of the special methods of accounting 
referred

[[Page 584]]

to in subparagraph (2) of this paragraph which was made pursuant to any 
provisions of the Internal Revenue Code of 1954 or prior revenue laws 
for purposes of determining a company's tax liabilities for prior years, 
shall have the same force and effect in determining the items of gross 
investment income under section 804(b) and the items of deduction under 
section 804(c) of the Life Insurance Company Income Tax Act of 1959 (73 
Stat. 112) as if such Act had not been enacted.
    (ii) For purposes of determining gain or loss from operations under 
section 809(b), in computing the life insurance company's share of 
investment yield under section 809(b) (1)(A) and (2)(A), an election 
with respect to any of the special methods of accounting referred to in 
subparagraph (2) of this paragraph which was made pursuant to any 
provision of the Internal Revenue Code of 1954 or prior revenue laws, 
shall not be affected in any way by the enactment of the Life Insurance 
Company Income Tax Act of 1959 (73 Stat. 112).
    (iii) For purposes of determining gain or loss from operations under 
section 809(b), in computing the items of gross amount under section 
809(c) and the deduction items under section 809(d), an election to use 
any of the special methods of accounting referred to in subparagraph (2) 
of this paragraph must be made in accordance with the specific statutory 
provisions of the sections containing such elections and the regulations 
thereunder. However, where a particular election may be made only with 
the consent of the Commissioner (either because the time for making the 
election without the consent of the Commissioner has expired or because 
the particular section contained no provision for making an election 
without consent), and the time prescribed by the applicable regulations 
for submitting a request for permission to make such an election for the 
taxable year 1958 has expired, a life insurance company may make such an 
election for the year 1958 at the time of filing its return for that 
year (including extensions thereof). For example, a life insurance 
company may elect any of the methods of depreciation prescribed in 
section 167 (to the extent permitted under that section and the 
regulations thereunder) with respect to those assets, or any portion 
thereof, for which no depreciation was allowable under prior revenue 
laws, for example, furniture and fixtures used in the underwriting 
department. Similarly, a life insurance company shall be permitted to 
make an election under section 461(c) (relating to the accrual of real 
property taxes) with respect to real property for which no deduction was 
allowable under prior revenue laws. Any such election shall be made in 
the manner and form prescribed in the applicable regulations.
    (iv) For purposes of subdivision (ii) of this subparagraph, the 
method used under section 1016(a)(3)(C) (relating to adjustments to 
basis) in determining the amount of exhaustion, wear and tear, 
obsolescence, and amortization actually sustained shall not preclude a 
taxpayer from electing any of the methods prescribed in section 167 in 
accordance with the provisions of that section and the regulations 
thereunder for determining the amount of such exhaustion, wear and tear, 
obsolescence, and amortization for the year 1958. For example, if the 
amount of depreciation actually sustained, under section 1016(a)(3)(C), 
on a life insurance company's home office building (other than that 
portion for which depreciation was allowable under prior revenue laws) 
is determined on the straight line method, the life insurance company 
may elect for the year 1958 to use any of the methods prescribed in 
section 167 for determining its depreciation allowance for 1958. 
However, such election shall be binding for 1958, and for all subsequent 
taxable years, unless consent to change such election, if required, is 
obtained from the Commissioner in accordance with the provisions of 
section 167 and the regulations thereunder.
    (4)(i) For purposes of section 805(b)(3)(B)(i) (relating to the 
determination of the current earnings rate for any taxable year 
beginning before January 1, 1958), the determination for any year of the 
investment yield and the assets shall be made as though the taxpayer had 
been on the accrual method prescribed in subparagraph (1) of this 
paragraph for such year, or the accrual method in combination with

[[Page 585]]

the other methods of accounting prescribed in subparagraph (2) of this 
paragraph, if these other methods of accounting are used by the taxpayer 
in determining the investment yield and assets for the taxable year 
1958. However, where the method used for determining the deduction under 
section 167 for the year 1958 differs from the method used in prior 
years, the amount of the deduction actually allowed or allowable for 
such prior years for purposes of section 1016(a)(2) (relating to 
adjustments to basis) shall be the amount to be taken into account in 
determining the current earnings rate under section 805(b)(3)(B)(i).
    (ii) For purposes of section 812(b)(1)(C) (relating to operations 
loss carrybacks and carryovers for years prior to 1958), the 
determination for those years of the gain or loss from operations shall 
be made as though the taxpayer had been on the accrual method of 
accounting prescribed in subparagraph (1) of this paragraph for such 
year, or the accrual method in combination with the other methods of 
accounting prescribed in subparagraph (2) of this paragraph, if these 
other methods of accounting are used by the taxpayer in the 
determination of gain or loss from operations for the taxable year 1958. 
However, where any adjustment to basis is required under section 
1016(a)(3)(C) on account of exhaustion, wear and tear, obsolescence, 
amortization, and depletion sustained, the amount actually sustained as 
determined under section 1016(a)(3)(C) for each of the years involved 
shall be the amount allowed in the determination of gain or loss from 
operations for purposes of section 812(b)(1)(C).
    (b) Adjustments required if accrual method of accounting was not 
used in 1957. The items of gross amount taken into account under section 
809(c) and the items of deductions allowed under section 809(d) for the 
taxable year 1958 shall be determined as though the taxpayer had been on 
the accrual method of accounting prescribed in paragraph (a) of this 
section for all prior years. Thus, life insurance companies not on the 
accrual method for the year 1957 shall accrue, as of December 31, 1957, 
those items of gross amount which would have been properly taken into 
account for the year 1957 if the company had been on the accrual method 
described in section 818(a). Likewise, life insurance companies not on 
the accrual method for the year 1957 shall accrue, as of December 31, 
1957, those items of deductions which would have been properly allowed 
for the year 1957 if the company had been on the accrual method 
described in section 818(a). For example, if certain premium amounts 
were received during the year 1958 but such amounts would have been 
properly taken into account for the year 1957 if the taxpayer had been 
on the accrual method for the year 1957, then the taxpayer will not be 
required to take such premium amounts into account for the year 1958. 
If, for example, certain claims, benefits, and losses were paid during 
the year 1958 but such items would have been properly taken into account 
for the year 1957 if the taxpayer had been on the accrual method for the 
year 1957, then the taxpayer will not be permitted to deduct such 
expense items for the year 1958. For a special transitional rule 
applicable with respect to changes in method of accounting required by 
section 818(a) and paragraph (a) of this section, see section 818(e) and 
Sec. 1.818-6.
    (c) Change of basis in computing reserves. (1) Section 806(b) 
provides that if the basis for determining the amount of any item 
referred to in section 810(c) as of the close of the taxable year 
differs from the basis for such determination as of the beginning of the 
taxable year, then for purposes of subpart B, part I, subchapter L, 
chapter 1 of the Code (relating to the determination of taxable 
investment income), the amount of such item shall be the amount computed 
on the old basis as of the close of the taxable year and the amount 
computed on the new basis as of the beginning of the next taxable year. 
Similarly, section 810(d)(1) provides rules for determining the amount 
of the adjustment to be made for purposes of subpart C, part I, 
subchapter L, chapter 1 of the Code (relating to the determination of 
gain or loss from operations), if the basis for determining any item 
referred to in section 810(c) as of the close of any taxable

[[Page 586]]

year differs from the basis for such determination as of the close of 
the preceding taxable year. Under an accrual method of accounting, a 
change in the basis or method of computing the amount of liability of 
any item referred to in section 810(c) occurs in the taxable year in 
which all the events have occurred which determine the change in the 
basis or method of computing the amount of such liability and, in which, 
the amount thereof (whether increased or decreased) can be determined 
with reasonable accuracy.
    (2) The application of subparagraph (1) of this paragraph may be 
illustrated by the following examples:

    Example 1. Assume that during the taxable year 1960, M, a life 
insurance company, determines that the amount of its life insurance 
reserves held with respect to a particular block of contracts is 
understated on the present basis being used in valuing such liability 
and that such liability can be more accurately reflected by changing 
from the present basis to a particular new basis. Assume that M uses 
such new basis in computing its reserves under such contracts at the end 
of the taxable year 1960. Under the provisions of section 818(a) and 
subparagraph (1) of this paragraph, the change in basis for purposes of 
sections 806(b) and 810(d) occurs during the taxable year 1960, the year 
in which all the events have occurred which determine the change in 
basis and the amount of any increase (or decrease) attributable to such 
change can be determined with reasonable accuracy. Such change shall be 
treated as having occurred during the taxable year 1960 whether M 
determines that its liability under such contracts was understated for 
the first time during 1960, or that its liability under such contracts 
has, in fact, been understated for a number of prior years.
    Example 2. Assume the facts are the same as in example 1, except 
that during the taxable year 1960 the insurance department of State X 
issues a ruling, pursuant to authority conferred by statute, requiring M 
to use the particular new basis which more accurately reflects its 
liability with respect to such contracts and that as a result of such 
ruling, M uses the new basis in computing its reserves under such 
contracts for the taxable years 1958, 1959, and 1960. Under the 
provisions of section 818(a) and subparagraph (1) of this paragraph, the 
change in basis for purposes of sections 806(b) and 810(d) occurs during 
the taxable year 1960, the year in which all the events have occurred 
which determine that a change in basis should be made and the amount of 
any increase (or decrease) attributable to such change can be determined 
with reasonable accuracy.

[T.D. 6558, 26 FR 2785, Apr. 4, 1961]



Sec. 1.818-3   Amortization of premium and accrual of discount.

    (a) In general. Section 818(b) provides that the appropriate items 
of income, deductions, and adjustments under part I, subchapter L, 
chapter 1 of the Code, shall be adjusted to reflect the appropriate 
amortization of premium and the appropriate accrual of discount on 
bonds, notes, debentures, or other evidences of indebtedness held by a 
life insurance company. Such adjustments are limited to the amount of 
appropriate amortization or accrual attributable to the taxable year 
with respect to such securities which are not in default as to principal 
or interest and which are amply secured. The question of ample security 
will be resolved according to the rules laid down from time to time by 
the National Association of Insurance Commissioners. The adjustment for 
amortization of premium decreases the gross investment income, the 
exclusion and reduction for wholly tax-exempt interest, the exclusion 
and deduction for partially tax-exempt interest, and the basis or 
adjusted basis of such securities. The adjustment for accrual of 
discount increases the gross investment income, the exclusion and 
reduction for wholly tax-exempt interest, the exclusion and deduction 
for partially tax-exempt interest, and the basis or adjusted basis of 
such securities. However, for taxable years beginning after May 31, 
1960, only the accrual of discount relating to issue discount will 
increase the exclusion and reduction for wholly tax-exempt interest. See 
section 103.
    (b) Acquisitions before January 1, 1958. (1) In the case of any such 
security acquired before January 1, 1958, the premium is the excess of 
its acquisition value over its maturity value and the discount is the 
excess of its maturity value over its acquisition value. The acquisition 
value of any such security is its cost (including buying commissions or 
brokerage but excluding any amounts paid for accrued interest) if 
purchased for cash, or if not purchased for cash, its then fair market 
value.

[[Page 587]]

The maturity value of any such security is the amount payable thereunder 
either at the maturity date or an earlier call date. The earlier call 
date of any such security may be the earliest interest payment date if 
it is callable or payable at such date, the earliest date at which it is 
callable at par, or such other call or payment date, prior to maturity, 
specified in the security as may be selected by the life insurance 
company. A life insurance company which adjusts amortization of premium 
or accrual of discount with reference to a particular call or payment 
date must make the adjustments with reference to the value on such date 
and may not, after selecting such date, use a different call or payment 
date, or value, in the calculation of such amortization or discount with 
respect to such security unless the security was not in fact called or 
paid on such selected date.
    (2) The adjustments for amortization of premium and accrual of 
discount will be determined:
    (i) According to the method regularly employed by the company, if 
such method is reasonable, or
    (ii) According to the method prescribed by this section.

A method of amortization of premium or accrual of discount will be 
deemed ``regularly employed'' by a life insurance company if the method 
was consistently followed in prior taxable years, or if, in the case of 
a company which has never before made such adjustments, the company 
initiates in the first taxable year for which the adjustments are made a 
reasonable method of amortization of premium or accrual of discount and 
consistently follows such method thereafter. Ordinarily, a company 
regularly employs a method in accordance with the statute of some State, 
Territory, or the District of Columbia, in which it operates.
    (3) The method of amortization and accrual prescribed by this 
section is as follows:
    (i) The premium (or discount) shall be determined in accordance with 
this section; and
    (ii) The appropriate amortization of premium (or accrual of 
discount) attributable to the taxable year shall be an amount which 
bears the same ratio to the premium (or discount) as the number of 
months in the taxable year during which the security was owned by the 
life insurance company bears to the number of months between the date of 
acquisition of the security and its maturity or earlier call date, 
determined in accordance with this section. For purposes of this 
section, a fractional part of a month shall be disregarded unless it 
amounts to more than half a month, in which case it shall be considered 
a month.
    (c) Acquisitions after December 31, 1957. (1) In the case of:
    (i) Any bond, as defined in section 171(d), acquired after December 
31, 1957, the amount of the premium and the amortizable premium for the 
taxable year, shall be determined under section 171(b) and the 
regulations thereunder, as if the election set forth in section 171(c) 
had been made, and
    (ii) Any bond, note, debenture, or other evidence of indebtedness 
not described in subdivision (i) of this subparagraph and acquired after 
December 31, 1957, the amount of the premium and the amortizable premium 
for the taxable year, shall be determined under paragraph (b) of this 
section.
    (2) In the case of any bond, note, debenture, or other evidence of 
indebtedness acquired after December 31, 1957, the amount of the 
discount and the accrual of discount attributable to the taxable year 
shall be determined under paragraph (b) of this section.
    (d) Convertible evidences of indebtedness. Section 818(b)(2)(B) 
provides that in no case shall the amount of premium on a convertible 
evidence of indebtedness (including any bond, note, or debenture) 
include any amount attributable to the conversion features of the 
evidence of indebtedness. This provision is the same as the one 
contained in section 171(b), and the rules prescribed in paragraph (c) 
of Sec. 1.171-2 shall be applicable for purposes of section 
818(b)(2)(B). This provision is to be applied without regard to the date 
upon which the evidence of indebtedness was acquired. Thus, where a 
convertible evidence of indebtedness was acquired before January 1, 
1958, and a portion or all of the premium attributable to the conversion 
features of the

[[Page 588]]

evidence of indebtedness has been amortized for taxable years beginning 
before January 1, 1958, no adjustment for such amortization will be 
required by reason of section 818(b)(2)(B). Such amortization will, 
however, require an adjustment to the basis of the evidence of 
indebtedness under section 1016(a)(17). For taxable years beginning 
after December 31, 1957, no further amortization of the premium 
attributable to the conversion features of such an evidence of 
indebtedness will be taken into account.
    (e) Adjustments to basis. Section 1016(a)(17) (relating to 
adjustments to basis) provides that in the case of any evidence of 
indebtedness referred to in section 818(b) and this section, the basis 
shall be adjusted to the extent of the adjustments required under 
section 818(b) (or the corresponding provisions of prior income tax 
laws) for the taxable year and all prior taxable years. The basis of any 
evidence of indebtedness shall be reduced by the amount of the 
adjustment required under section 818(b) (or the corresponding provision 
of prior income tax laws) on account of amortizable premium and shall be 
increased by the amount of the adjustment required under section 818(b) 
on account of accruable discounts.
    (f) Denial of double inclusion. Any amount which is includible in 
gross investment income by reason of section 818(b) and paragraph (a) of 
this section shall not be includible in gross income under section 
1232(a) (relating to the taxation of bonds and other evidences of 
indebtedness). See section 1232(a)(2)(C) and the regulations thereunder.

[T.D. 6558, 26 FR 2786, Apr. 4, 1961]



Sec. 1.818-4   Election with respect to life insurance reserves computed on preliminary term basis.

    (a) In general. Section 818(c) permits a life insurance company 
issuing contracts with respect to which the life insurance reserves are 
computed on one of the recognized preliminary term bases to elect to 
revalue such reserves on a net level premium basis for the purpose of 
determining the amount which may be taken into account as life insurance 
reserves for purposes of part I, subchapter L, chapter 1 of the Code, 
other than section 801 (relating to the definition of a life insurance 
company). If such an election is made, the method to be used in making 
this revaluation of reserves shall be either the exact revaluation 
method (as described in section 818(c)(1) and paragraph (b)(1) of this 
section) or the approximate revaluation method (as described in section 
818(c)(2) and paragraph (b)(2) of this section).
    (b) Revaluation of reserves computed on preliminary term basis. If a 
life insurance company makes an election under section 818(c) in the 
manner provided in paragraph (e) of this section, the amount to be taken 
into account as life insurance reserves with respect to contracts for 
which such reserves are computed on a preliminary term basis may be 
determined on either of the following bases:
    (1) Exact revaluation method. As if the reserves for all such 
contracts had been computed on a net level premium basis (using the same 
mortality or morbidity assumptions and interest rates for both the 
preliminary term basis and the net level premium basis).
    (2) Approximate revaluation method. The amount computed without 
regard to section 818(c):
    (i) Increased by $21 per $1,000 of insurance in force (other than 
term insurance) under such contracts, less 2.1 percent of reserves under 
such contracts, and
    (ii) Increased by $5 per $1,000 of term insurance in force under 
such contracts which at the time of issuance cover a period of more than 
15 years, less 0.5 percent of reserves under such contracts.
    (c) Exception. If a life insurance company which makes an election 
under section 818(c)(2) and paragraph (b)(2) of this section has life 
insurance reserves with respect to both life insurance and 
noncancellable accident and health contracts for which such reserves are 
computed on a preliminary term basis, it shall use the approximate 
revaluation method for all its life insurance reserves other than that 
portion of such reserves held with respect to its noncancellable 
accident and health contracts, and shall use the exact revaluation 
method for all its life insurance reserves held with respect to such

[[Page 589]]

noncancellable accident and health contracts.
    (d) Reserves subject to recomputation. (1) For the first taxable 
year for which the election under section 818(c) and paragraph (b) of 
this section applies, a company making such election must revalue all 
its life insurance reserves held with respect to contracts for which 
such reserves are computed on a preliminary term basis at the end of 
such taxable year on the basis elected under section 818(c) and 
paragraph (b) of this section. However, for purposes of the preceding 
sentence, an election under section 818(c) shall not apply with respect 
to such reserves which would not be treated as being computed on the 
preliminary term basis at the end of such taxable year except for the 
provisions of section 810 (a) or (b). See paragraph (c)(2) of 
Sec. 1.810-2. For example, if S, a life insurance company which computes 
its life insurance reserves on a recognized preliminary term basis at 
the beginning of the taxable year 1958, strengthens a portion of such 
reserves during the taxable year by actually changing to a net level 
premium basis in computing such reserves, and then makes the election 
under section 818(c) and paragraph (b) of this section for 1958, such 
election shall not apply with respect to the strengthened contracts.
    (2) For any taxable year other than the first taxable year for which 
the election under section 818(c) and paragraph (b) of this section 
applies, a company making such election must revalue all its life 
insurance reserves held with respect to contracts for which such 
reserves are computed on a preliminary term basis at the beginning or 
end of the taxable year on the basis elected under section 818(c) and 
paragraph (b) of this section. For example, if M, a life insurance 
company which made a valid outstanding election under section 818(c) in 
the manner provided in paragraph (e) of this section for the taxable 
year 1959, sells a block of contracts subject to such election on 
September 1, 1960, M would value such contracts on the basis elected 
under section 818(c) and paragraph (b) of this section on January 1, 
1960, for purposes of determining the net decrease or increase in the 
sum of the items described in section 810(c) for the taxable year under 
section 810 (a) or (b).
    (3) For the effect of an election under section 818(c) and paragraph 
(b) of this section in determining gain or loss from operations for the 
taxable year, see paragraph (c)(3) of Sec. 1.810-2 and paragraph (e) of 
Sec. 1.810-3.
    (e) Time and manner of making election. The election provided by 
section 818(c) shall be made in a statement attached to the life 
insurance company's income tax return for the first taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. However, if the last day prescribed by law (including extensions 
thereof) for filing a return for the first taxable year for which the 
company desires the election to apply falls before April 4, 1961, the 
election provided by section 818(c) may be made for such year by filing 
the statement and an amended return for such taxable year (and all 
subsequent taxable years for which returns have been filed) before July 
4, 1961. The statement shall indicate whether the exact or the 
approximate method of revaluation has been adopted. The statement shall 
also set forth sufficient information as to mortality and morbidity 
asumptions; interest rates; the valuation method used; the amount of the 
reserves and the amount and type of insurance in force under all 
contracts for which reserves are computed on a preliminary term basis; 
and such other pertinent data as will enable the Commissioner to 
determine the correctness of the application of the revaluation method 
adopted and the accuracy of the computations involved in revaluing the 
reserves. The election to use either the exact revaluation method or the 
approximate revaluation method shall, except for the purposes of section 
801, be adhered to in making the computations under part I for the 
taxable year for which such election is made and for all subsequent 
taxable years.
    (f) Scope of election. An election made under section 818(c) and 
paragraph (b) of this section to use either the exact

[[Page 590]]

or the approximate method of revaluing the company's life insurance 
reserves shall be binding for the taxable year for which made, and, 
except as provided in paragraph (g) of this section, shall be binding 
for all succeeding taxable years, unless consent to revoke the election 
is obtained from the Commissioner. However, for taxable years beginning 
prior to April 4, 1961, a company may revoke the election provided by 
section 818(c) without obtaining consent from the Commissioner by 
filing, before July 4, 1961, a statement that the company desires to 
revoke such election. An amended return reflecting such revocation must 
accompany the statement for all taxable years for which returns have 
been filed with respect to such election.
    (g) Special rule for 1958. If an election is made for a taxable year 
beginning in 1958 to use the approximate revaluation method described in 
section 818(c)(2) and paragraph (b)(2) of this section the company may, 
for its first taxable year beginning after 1958, elect to change to the 
exact revaluation method described in section 818(c)(1) and paragraph 
(b)(1) of this section without obtaining the consent of the 
Commissioner. In such case, the election to change shall be made in a 
statement attached to the company's income tax return for such taxable 
year and filed not later than the date prescribed by law (including 
extensions thereof) for filing the return for such year. The statement 
shall indicate that the company has elected to change from the 
approximate to the exact revaluation method for such taxable year and 
shall include such information and data referred to in paragraph (e) of 
this section as will enable the Commissioner to determine the 
correctness and accuracy of the computations involved.

[T.D. 6558, 26 FR 2787, Apr. 4, 1961; 26 FR 3276, Apr. 18, 1961]



Sec. 1.818-5   Short taxable years.

    (a) In general. Section 818(d) provides that if any return of a 
corporation made under part I, subchapter L, chapter 1 of the Code, is 
for a period of less than the entire calendar year, then section 443 
(relating to returns for a period of less than 12 months) shall not 
apply. This section further provides certain rules to be used in 
determining the life insurance company taxable income for a period of 
less than the entire calendar year.
    (b) Returns for periods of less than the entire calendar year. A 
return for a short period, that is, for a taxable year consisting of a 
period of less than the entire calendar year, shall be made only under 
the following circumstances:
    (1) If a company which qualifies as a life insurance company is not 
in existence for the entire taxable year, a return is required for the 
short period during which the taxpayer was in existence. For example, a 
life insurance company organized on August 1, is required to file a 
return for the short period from August 1 to December 31, and returns 
for each calendar year thereafter. Similarly, if a company which 
qualifies as a life insurance company completely dissolves during the 
taxable year it is required to file a return for the short period from 
January 1 to the date it goes out of existence. All items entering into 
the computation of taxable investment income and gain or loss from 
operations for the short period shall be determined on a consistent 
basis and in the manner provided in paragraph (c) of this section.
    (2) A return must be filed for a short period resulting from the 
termination by the district director of a taxpayer's taxable year for 
jeopardy. See section 6851 and the regulations thereunder.

A company which was an insurance company for the preceding taxable year 
(but not a life insurance company as defined in section 801(a) and 
paragraph (b) of Sec. 1.801-3) and which for the current taxable year 
qualifies as a life insurance company shall not file a return for the 
short period from the time during the taxable year that it first 
qualifies as a life insurance company to the end of the taxable year. 
Similarly, an insurance company which was a life insurance company for 
the preceding taxable year but which for the current taxable year does 
not qualify as a life insurance company shall not file a return for the 
short period from the beginning of the taxable year to the time during 
the taxable year that it no

[[Page 591]]

longer qualifies as a life insurance company.
    (c) Computation of life insurance company taxable income for short 
period. (1) If a return is made for a short period, section 818(d)(1) 
provides that the taxable investment income and the gain or loss from 
operations shall be determined on an annual basis by a ratable daily 
projection of the appropriate figures for the short period. The 
appropriate figures for the short period shall be determined on an 
annual basis by multiplying such figures by a fraction, the numerator of 
which is the number of days in the calendar year in which the short 
period occurs and the denominator of which is the number of days in the 
short period.
    (2)(i) In computing taxable investment income for a short period, 
the investment yield, the policy and other contract liability 
requirements, the policyholders' share of each and every item of 
investment yield, and the company's share of any item of investment 
yield shall be determined on an annual basis.
    (ii) For purposes of determining the investment yield on an annual 
basis, each item of gross investment income under section 804(b) and 
each item of deduction under section 804(c) shall be annualized in the 
manner provided in subparagraph (1) of this paragraph. In any case in 
which a limitation is placed on the amount of a deduction provided under 
section 804(c), the limitation shall apply to the item of deduction 
computed on an annual basis.
    (iii) The policy and other contract liability requirements shall be 
determined on an annual basis in the following manner:
    (a) The interest paid (as defined in section 805(e) and Sec. 1.805-
8) for the short period shall be annualized in the manner prescribed in 
subparagraph (1) of this paragraph.
    (b) The current earnings rate for the taxable year in which the 
short period occurs shall be determined by dividing the taxpayer's 
investment yield, as determined on an annual basis under subdivision 
(ii) of this subparagraph, by the mean of the taxpayer's assets at the 
beginning and end of the short period. For purposes of section 805, any 
reference to the current earnings rate for the taxable year in which the 
short period occurs means the current earnings rate as determined under 
this subdivision.
    (c) The adjusted life insurance reserves shall be determined as 
provided in section 805(c), and the pension plan reserves shall be 
determined as provided in section 805(d).
    (iv) The policyholders' share of each and every item of investment 
yield (as defined in section 804(a)) shall be that percentage obtained 
by dividing the policy and other contract liability requirements, 
determined under subdivision (iii) of this subparagraph, by the 
investment yield, determined under subdivision (ii) of this 
subparagraph.
    (v) The taxable investment income for the short period shall be an 
amount (not less than zero) equal to the life insurance company's share 
of each and every item of investment yield, as determined under 
subdivision (ii) of this subparagraph, reduced by the items described in 
section 804(a)(2) (A) and (B). In determining these reductions under 
section 804(a)(2)(A) the amount of the respective items shall be the 
amount that is determined on an annual basis under subdivision (ii) of 
this subparagraph. The small business deduction, under section 
804(a)(2)(B) shall be an amount (not to exceed $25,000) equal to 10 
percent of the investment yield, determined under subdivision (ii) of 
this subparagraph, for the short period.
    (vi) Except as provided in this paragraph, the determination of 
taxable investment income under subpart B, part I, subchapter L, chapter 
1 of the Code, shall be made in accordance with all the provisions of 
that subpart.
    (3)(i) In computing gain or loss from operations for a short period, 
the share of each and every item of investment yield set aside for 
policyholders, the life insurance company's share of each and every item 
of investment yield, the items of gross amount, and the items of 
deduction shall, except as modified by this subparagraph, be determined 
on an annual basis in the manner provided in subparagraph (1) of this 
paragraph. In any case in which a limitation is placed on the amount of 
a deduction provided under section 809, the limitation shall apply to 
the item of deduction computed on an annualized basis.

[[Page 592]]

    (ii) For purposes of sections 809 and 810, the investment yield 
shall be determined in the manner provided in subparagraph (2)(ii) of 
this paragraph. The share of any item of investment yield set aside for 
policyholders shall be that percentage obtained by dividing the required 
interest as determined under section 809(a)(2), by the investment yield, 
as determined in this subparagraph, except that if the required interest 
exceeds the investment yield then the share of any item of investment 
yield set aside for policyholders shall be 100 percent.
    (iii) The items of gross amount and the items of deduction, other 
than the operations loss deduction under section 809(d)(4), shall be 
determined on an annual basis. See subdivision (iv) of this subparagraph 
for the manner in which the net decrease or net increase in reserves 
under section 810 shall be annualized.
    (iv) For purposes of determining either a net decrease in reserves 
under section 810(a) or a net increase in reserves under section 810(b), 
the sum of the items described in section 810(c) as of the end of the 
short period shall be reduced by the amount of the investment yield not 
included in gain or loss from operations for the short period by reason 
of section 809(a)(1). The amount of investment yield excluded under 
section 809(a)(1) has been determined upon an annualized basis while the 
sum of the items described in section 180(c) at the end of the short 
period has been determined on an actual basis. In order to place these 
on the same basis, the amount of investment yield not included in gain 
or loss from operations by reason of section 809(a)(1), determined under 
subdivision (ii) shall, for purposes of section 810(a) and section 
810(b), be reduced to an amount which bears the same ratio to the full 
amount as the number of days in the short period bears to the number of 
days in the entire calendar year. The net decrease or the net increase 
of the items referred to in section 810(c) for the short period shall 
then be determined, as provided in section 810(a) and section 810(b), 
respectively, and the result annualized.
    (4) The portion of the life insurance company taxable income 
described in section 802(b) (1) and (2) (relating to taxable investment 
income and gain or loss from operations) shall be determined on an 
annual basis by treating the amounts ascertained under subparagraph (2) 
of this paragraph as the taxable investment income, and the amount 
ascertained under subparagraph (3) of this paragraph as the gain or loss 
from operations, for the taxable year.
    (5) The portion of the life insurance company taxable income 
described in section 802(b) (1) and (2) for the short period shall be 
the amount which bears the same ratio to the amount ascertained under 
section 818(d) (2) and subparagraph (4) of this paragraph as the number 
of days in the short period bears to the number of days in the entire 
year.
    (d) Special rules. (1) For purposes of determining the average 
earnings rate (as defined in section 805(b)(3)) for subsequent taxable 
years, the current earnings rate for the taxable year in which the short 
period occurs shall be the rate determined under paragraph (c)(2) of 
this section.
    (2) For purposes of determining an operations loss deduction under 
section 812, the loss from operations for the short period shall be the 
loss from operations determined under paragraph (c)(5) of this section.

[T.D. 6558, 26 FR 2788, Apr. 4, 1961]



Sec. 1.818-6   Transitional rule for change in method of accounting.

    (a) In general. Section 818(e) prescribes the rules to be followed 
in recomputing the taxes of a life insurance company for the taxable 
year 1957 in cases where the method of accounting required to be used in 
computing the company's taxes for 1958 under section 818(a) and 
paragraph (a) of Sec. 1.818-2 is different from the method used in 1957.
    (b) Recomputation of 1957 taxes. (1) For purposes of recomputing its 
taxes for 1957, a life insurance company must ascertain the net amount 
of those adjustments which are determined (as of the close of 1957) to 
be necessary solely by reason of the change to the method of accounting 
required by section 818(a) and paragraph (a) of Sec. 1.818-2 in order to 
prevent amounts from being duplicated

[[Page 593]]

or omitted. Thus, for example, life insurance companies not on the 
accrual method of accounting for the year 1957 shall accrue, as of 
December 31, 1957, those items of gross investment income under section 
803(b) and those items of deduction under section 803(c), as in effect 
for 1957, which would have been properly accruable for the year 1957 if 
the company had been on the accrual method of accounting.
    (2) In the case of a change in the over-all method of accounting, 
the term ``net amount of those adjustments'' means the consolidation of 
adjustments (whether the amounts thereof represent increases or 
decreases in items of income or deductions) arising with respect to 
balances in the various accounts on December 31, 1957. In the case of a 
change in the treatment of a single material item, the amount of the 
adjustment shall be determined with reference only to the net dollar 
balances in that particular account.
    (3)(i) The amount of the taxpayer's tax for 1957 shall be recomputed 
(under the law applicable to 1957, modified as provided in section 
818(e) (4) and paragraph (e) of this section) by taking into account an 
amount equal to one-tenth of the net amount of the adjustments 
determined under subparagraph (1) of this paragraph. The increase or 
decrease in tax attributable to the adjustments for such year is the 
difference between the tax for such year computed with the allocation of 
one-tenth of the net amount of the adjustments to such taxable year over 
the tax computed without the allocation of any part of the adjustments 
to such year.
    (ii) The amount of increase or decrease (as the case may be) 
referred to in section 818(e) (2) or (3) and paragraphs (c) or (d) of 
this section, shall be the amount of the increase or decrease in tax 
ascertained in the manner described in subdivision (i) of this 
subparagraph, multiplied by 10.
    (c) Treatment of decrease. Section 818(e) (2) provides that for 
purposes of subtitle F of the Code, if the recomputation under paragraph 
(b) (3) (ii) of this section results in a decrease, the amount of such 
decrease shall be treated as a decrease in the tax imposed for 1957; 
except that for purposes of computing the period of limitation on the 
making of refunds or the allowance of credits with respect to such 
overpayments, the amount of such decrease shall be treated as an 
overpayment of tax for 1959. No interest shall be paid, for any period 
before March 16, 1960, on any overpayment of the tax imposed for 1957 
which is attributable to such decrease.
    (d) Treatment of increase--(1) In general. Section 818(e) (3) (A) 
provides that for purposes of subtitle F of the Code, other than section 
6016 (relating to declarations of estimated income tax by corporations) 
and section 6655 (relating to failure by corporations to pay estimated 
income tax), if the recomputation under paragraph (b) (3) (ii) of this 
section results in an increase, the amount of such increase shall be 
treated as a tax imposed for 1959. Such tax shall be payable in 10 equal 
annual installments, beginning with March 15, 1960.
    (2) Special rules. Section 818(e) (3) (B) provides that for purposes 
of section 818(e) (3) (A) and subparagraph (1) of this paragraph:
    (i) No interest shall be paid on any installment described in 
section 818(e) (3) (A) and subparagraph (1) of this paragraph before the 
time prescribed therein for the payment of such installment.
    (ii) Section 6152(c) (relating to proration of deficiencies to 
installments) and the regulations thereunder shall apply. However, 
section 6152(a) (relating to the election to make installment payments) 
and the regulations thereunder shall not apply.
    (iii) In applying section 6502(a) (1) (relating to collection after 
assessment) and the regulations thereunder, the assessment of any 
installment described in section 818(e) (3) (A) and subparagraph (1) of 
this paragraph shall be treated as made at the time prescribed therein 
for the payment of such installment.
    (iv) If for any taxable year the taxpayer is not a life insurance 
company, the amount of the increase in tax (as determined under 
paragraph (b) (3) (ii) of this section), to the extent not taken into 
account for prior taxable years, shall be payable on the date the

[[Page 594]]

return for such taxable year is due (determined without regard to any 
extensions of time for filing such return), unless such amount is 
required to be taken into account by the acquiring corporation under 
section 381(c) (22) and the regulations thereunder.
    (e) Modifications of 1957 tax computation. Section 818(e) (4) 
provides that in recomputing the taxpayer's tax for 1957 for purposes of 
section 818(e) (1) and paragraph (b) of this section:
    (1) Section 804(b), as in effect for 1957 (relating to the maximum 
reserve and other policy liability deduction), shall not apply with 
respect to any amount required to be taken into account by reason of 
section 818(e) (1) and paragraph (b) of this section; and
    (2) The amount of the deduction allowed by section 805, as in effect 
for 1957 (relating to the special interest deduction), shall not be 
reduced by reason of any amount required to be taken into account under 
section 818(e) (1) and paragraph (b) of this section.
    (f) Illustration of principles. The application of section 818(e) 
and this section may be illustrated by the following examples:

    Example 1. For the taxable year 1957, the life insurance taxable 
income of M, a life insurance company, is $200,000 computed on the cash 
receipts and disbursements method of accounting. The net amount of the 
adjustments required under section 818(e)(1) by reason of the change to 
the accrual method of accounting for 1958, increases M's life insurance 
taxable income for 1957 by $50,000. The increase in tax attributable to 
the change in method of accounting required by section 818(a) is 
$26,000, computed as follows:

(1) Life insurance taxable income before adjustments........    $200,000
(2) Adjustments required by sec. 818(e) (1) (1/10 x $50,000)       5,000
(3) Life insurance taxable income after adjustments (item               
 (1) plus item (2)).........................................     205,000
(4) Tax liability after adjustments (52% x $205,000, minus              
 $5,500)....................................................     101,100
(5) Tax liability before adjustments (52% x $200,000, minus             
 $5,500)....................................................      98,500
(6) Excess of item (4) over item (5)........................       2,600
(7) Increase in tax for purposes of sec. 818(e) (3) (item               
 (6) multiplied by 10)......................................      26,000
                                                                        

Under the provisions of section 818(e)(3), one-tenth of the increase in 
tax for 1957 attributable to the change in method of accounting required 
by section 818(a), $2,600 (1/10 x $26,000), was due and payable on March 
15, 1960, and the balance, $23,400 (9/10 x $26,000), is due and payable 
in equal installments on March 15th of the nine succeeding taxable 
years. However, if for the taxable year 1965, M is no longer a life 
insurance company, and section 381(c)(22) does not apply, the balance of 
the installments not paid in prior taxable years, $10,400 (4/
10 x $26,000), shall be due and payable on March 15, 1966.
    Example 2. Assume the facts are the same as in example 1, except 
that the net amount of the adjustments required by section 818(e)(1) 
decreases M's life insurance taxable income for 1957 by $25,000. The 
decrease in tax attributable to the change in method of accounting 
required by section 818(a) is $13,000, computed as follows:

(1) Life insurance taxable income before adjustments........    $200,000
(2) Adjustments required by sec. 818(e) (1) (1/10 x $25,000)       2,500
(3) Life insurance taxable income after adjustments (item               
 (1) minus item (2))........................................     197,500
(4) Tax liability after adjustments (52% x $197,500, minus              
 $5,500)....................................................      97,200
(5) Tax liability before adjustments (52% x $200,000, minus             
 $5,500)....................................................      98,500
(6) Excess of item (5) over item (4)........................       1,300
(7) Decrease in tax for purposes of sec. 818(e)(2) (item (6)            
 multiplied by 10)..........................................      13,000
                                                                        

Under the provisions of section 818(e)(2), the entire $13,000 decrease 
in tax for 1957 attributable to the change in method of accounting 
required by section 818(a) shall be treated as an overpayment of tax for 
the taxable year 1959.

[T.D. 6558, 26 FR 2789, Apr. 4, 1961]



Sec. 1.818-7   Denial of double deductions.

    Section 818(f) provides that the same item may not be deducted more 
than once under subpart B, part I, subchapter L, chapter 1 of the Code 
(relating to the determination of taxable investment income), and more 
than once under subpart C, part I, subchapter L, chapter 1 of the Code 
(relating to the determination of gain or loss from operations).

[T.D. 6558, 26 FR 2790, Apr. 4, 1961]



Sec. 1.818-8  Special rules relating to consolidated returns and certain capital losses.

    Section 818(g) provides that, in the case of a life insurance 
company filing or required to file a consolidated return under section 
1501 for a taxable

[[Page 595]]

year, the computations of the policyholders' share of investment yield 
under subparts B and C, part I, subchapter L, chapter 1 of the Code 
(including all determinations and computations incident thereto) shall 
be made as if such company were not filing a consolidated return. Thus, 
for example, if X and Y are life insurance companies which are entitled 
to file a consolidated return for 1975 and X has paid dividends to Y 
during such taxable year, Y must include such dividends in the 
computation of gross investment income under section 804(b). For other 
rules relating to the filing of consolidated returns, see sections 1501 
through 1504 and the regulations thereunder.

[T.D. 7469, 42 FR 12181, Mar. 3, 1977]



Sec. 1.819-1  Taxable years affected.

    Section 1.819-2 is applicable only to taxable years beginning after 
December 31, 1957, and all references to sections of part I, subchapter 
L, chapter 1 of the Code, are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
112).

[T.D. 6558, 26 FR 2791, Apr. 4, 1961]



Sec. 1.819-2   Foreign life insurance companies.

    (a) Carrying on United States insurance business. Section 819(a) 
provides that a foreign life insurance company carrying on a life 
insurance business within the United States, if with respect to its 
United States business it would qualify as a life insurance company 
under section 801, shall be taxable on its United States business under 
section 802 in the same manner as a domestic life insurance company. 
Thus, the life insurance company taxable income of such a foreign life 
insurance company shall not be determined in the manner provided by part 
I, subchapter N, chapter 1 of the Code (relating to determination of 
sources of income), but shall be determined in the manner provided by 
part I, subchapter L, chapter 1 of the Code (relating to life insurance 
companies). See section 842. Accordingly, in determining its life 
insurance company taxable income from its United States business, such a 
foreign life insurance company shall take into account the appropriate 
items of income irrespective of whether such items of income are from 
sources within or without the United States. A foreign life insurance 
company shall take into account the appropriate items of expenses, 
losses, and other deductions properly allocable to such items of income 
from its United States business. To the extent not inconsistent with the 
provisions of this paragraph, section 818(a), and section 819(b), all 
computations entering into the determination of taxes imposed by part I 
shall be made in a manner consistent with the manner required for 
purposes of the annual statement approved by the National Association of 
Insurance Commissioners.
    (b) Adjustment where surplus held in the United States is less than 
specified minimum--(1) In general. Section 819(b)(1) provides that if 
the minimum figure for the taxable year determined under section 
819(b)(2) and subparagraph (2)(i) of this paragraph exceeds the surplus 
held in the United States as of the end of the taxable year (as defined 
in section 819(b)(2)(B) and subparagraph (2)(ii) of this paragraph) by a 
foreign life insurance company carrying on a life insurance business 
within the United States and taxable under section 802, then:
    (i) The amount of the policy and other contract liability 
requirements (determined under section 805 and Sec. 1.805-4 without 
regard to this subparagraph), and
    (ii) The amount of the required interest (determined under section 
809(a)(2) and paragraph (d) of Sec. 1.809-2 without regard to this 
subparagraph),

shall each be reduced by an amount determined by multiplying such excess 
by the current earnings rate (as defined in section 805(b)(2) and 
paragraph (a)(2) of Sec. 1.805-5) of such company. Such current earnings 
rate shall be determined by reference to the assets held by the company 
in the United States.
    (2) Definitions. For purposes of section 819(b)(1) and subparagraph 
(1) of this paragraph:
    (i) The term minimum figure, in the case of a taxable year beginning 
after December 31, 1957, but before January 1, 1959, means the amount 
obtained by

[[Page 596]]

multiplying the company's total insurance liabilities on United States 
business by 9 percent. In the case of any taxable year beginning after 
December 31, 1958, such term means the amount obtained by multiplying 
the company's total insurance liabilities on United States business by 
the percentage determined and proclaimed by the Secretary as being 
applicable for such year.
    (ii) The term surplus held in the United States means the excess of 
the assets held in the United States (as of the end of the taxable year) 
over the total insurance liabilities on United States business (as of 
the end of the taxable year).
    (iii) The term total insurance liabilities means the sum of the 
total reserves (as defined in section 801(c) and paragraph (a) of 
Sec. 1.801-5) as of the end of the taxable year plus (to the extent not 
included in total reserves) the items referred to in section 810(c) (3), 
(4), and (5) of paragraph (b) (3), (4), and (5) of Sec. 1.810-2 as of 
the end of the taxable year; and
    (iv) The term assets shall have the same meaning as that contained 
in section 805(b)(4) and paragraph (a)(4) of Sec. 1.805-5.
    (3) Illustration of principles. The provisions of section 819(b) and 
this paragraph may be illustrated by the following example:

    Example. For the taxable year 1958, P, a foreign life insurance 
company carrying on a life insurance business within the United States 
and taxable under section 802, has total insurance liabilities on United 
States business (as of the end of the taxable year) of $940,000, assets 
held in the United States of $1,000,000 (as of the end of the taxable 
year), policy and other contract liability requirements in the amount of 
$30,000 required interest in the amount of $20,000, and a current 
earnings rate of 4 percent. In order to determine whether section 819(b) 
applies for the taxable year 1958, P must first compute its minimum 
figure, for if the minimum figure is less than the surplus held in the 
United States (as of the end of the taxable year), no section 819(b) 
adjustments need be made. Since the minimum figure, $84,600 ($940,000, 
the total insurance liabilities on United States business multiplied by 
9 percent, the percentage applicable for 1958), exceeds the surplus held 
in the United States, $60,000 (the excess of the assets held in the 
United States, $1,000,000, over the total insurance liabilities on 
United States business, $940,000), by $24,600, section 819(b) applies 
for the taxable year 1958. Thus, the amount of the policy and other 
contract liability requirements, $30,000, and the amount of the required 
interest, $20,000, shall each be reduced by $984 ($24,600, the amount of 
such excess, multiplied by 4 percent, the current earnings rate).

    (4) Segregated asset accounts. For taxable years beginning after 
December 31, 1967, pursuant to the provisions of section 801(g):
    (i) A foreign corporation carrying on a life insurance business 
which issues contracts based on segregated asset accounts shall 
separately compute in a manner consistent with this subparagraph the 
adjustment (if any) under section 819 to the amount of policy and other 
contract liability requirements and the amount of required interest 
properly attributable to each of such segregated asset accounts. The 
``minimum figure'' used in section 819 in making the adjustment with 
respect to each of the segregated asset accounts shall be computed as 
provided in subdivision (ii) of this subparagraph in lieu of the manner 
provided in subparagraphs (1), (2), and (3) of this paragraph.
    (ii) The minimum figure applicable to a segregated asset account 
referred to in subdivision (i) of this subparagraph is the amount 
determined by multiplying the total insurance liabilities on U.S. 
business attributable to such a segregated asset account, by 1 percent.
    (iii) The minimum figure as computed under subdivision (ii) of this 
subparagraph shall be compared only with the surplus held in the United 
States attributable to each segregated asset account referred to in 
subdivision (i) of this subparagraph. Such surplus is the excess of 
assets held in the United States properly attributable to such 
segregated asset account over the total insurance liabilities on U.S. 
business properly attributable to such account.
    (iv) If the minimum figure applicable to accounts other than 
segregated asset accounts exceeds the surplus held in the United States 
attributable to such other accounts, for purposes of section 819 and 
this paragraph, the amount of such excess shall not exceed

[[Page 597]]

the company's overall excess, as defined in this subdivision. No 
adjustment under section 819 or this paragraph shall be made with 
respect to any account if there is no such overall excess. For purposes 
of this subdivision and of subdivision (v) of this subparagraph, the 
term ``overall excess'' means the amount, if any, by which the aggregate 
minimum figures applicable to segregated asset accounts plus the minimum 
figure applicable to accounts other than segregated asset accounts 
exceeds the surplus held in the United States with respect to the 
company's entire U.S. life insurance business, including segregated 
asset accounts as well as other accounts.
    (v) In the case of a company which issues contracts based on one or 
more than one segregated asset account, if the minimum figure applicable 
to a segregated asset account exceeds the surplus held in the United 
States attributable to such account, then for purposes of section 819 
and this paragraph, the amount of such excess shall not exceed the 
account limitation figure, as defined in this subdivision. Therefore, no 
adjustment under section 819 or under this subparagraph shall be made 
with respect to any segregated asset account if the aggregate of the 
account limitation figures is zero, but nothing in this subdivision 
shall preclude an adjustment under section 819 with respect to accounts 
other than segregated asset accounts. For purposes of this subdivision, 
the term ``account limitation figure'' is a segregated assets account's 
proportionate share of the aggregate of the account limitation figures. 
Such aggregate of the account limitation figures is equal to the lesser 
of either the company's overall excess as defined in subdivision (iv) of 
this subparagraph, or the amount, if any, by which the aggregate of the 
minimum figures applicable to segregated asset accounts exceeds the 
surplus held in the United States with respect to all such segregated 
asset accounts. For purposes of this subdivision, a segregated asset 
account's proportionate share of the aggregate of the account limitation 
figures is determined by multiplying the amount of such aggregate of 
account limitation figures by a percentage, the numerator of which is 
the amount by which the minimum figure applicable to such account 
exceeds the surplus held in the United States attributable to such 
account, and the denominator of which is the aggregate of the amounts by 
which the minimum figure applicable to each segregated asset account 
exceeds the surplus held in the United States attributable to such 
account.
    (vi) Subdivisions (i), (ii), (iii), (iv), and (v) of this 
subparagraph may be illustrated by the following examples:

    Example 1. (a) For the taxable year 1968, T, a foreign life 
insurance company carrying on a life insurance business within the 
United States and taxable under section 802, has the following assets 
and total insurance liabilities with respect to such U.S. business:

------------------------------------------------------------------------
                                     Regular      Separate     Separate 
                                     account     account A    account B 
------------------------------------------------------------------------
Assets...........................   $9,300,000   $1,810,000     $515,000
Total insurance liabilities......    8,000,000    1,800,000      500,000
------------------------------------------------------------------------

It is further assumed that the percentage determined and proclaimed by 
the Secretary under section 819(a)(2)(A) for the taxable year 1968 is 15 
percent.
    (b) In order to determine whether any adjustment under section 819 
must be made, T must compute the minimum figure applicable to its 
Regular Account as well as each of its Separate Accounts. The minimum 
figure for the Regular Account is $1,200,000 (15 percent of $8,000,000). 
The minimum figure applicable to Separate Account A is $18,000 (1 
percent of $1,800,000). The minimum figure applicable to Separate 
Account B is $5,000 (1 percent of $500,000). The aggregate of the 
minimum figures is $1,223,000 ($1,200,000+$18,000+$5,000). The surplus 
held in the United States with respect to the Regular Account is 
$1,300,000 ($9,300,000-$8,000,000), with respect to Separate Account A 
is $10,000 ($1,810,000-$1,800,000) and with respect to Separate Account 
B is $15,000 ($515,000-$500,000). The surplus held in the United States 
with respect to T's entire U.S. life insurance business is $1,325,000 
($1,300,000+$10,000+$15,000).
    (c) Since the aggregate of the minimum figures ($1,223,000) does not 
exceed the surplus held in the United States attributable to T's entire 
U.S. life insurance business ($1,325,000), under subdivision (iv) of 
this subparagraph no adjustment under section 819 shall be made with 
respect to the Regular Account or either of the Separate Accounts.
    Example 2. (a) The facts are the same as in example 1 except that 
the assets held in the United States with respect to the Regular

[[Page 598]]

Account is $8,300,000 instead of $9,300,000. Thus, the surplus held in 
the United States with respect to the Regular Account is $300,000 
($8,300,000-$8,000,000), and the surplus held in the United States with 
respect to T's entire U.S. life insurance business is $325,000 
($300,000+$10,000 +$15,000).
    (b) Since the aggregate of the minimum figures with respect to the 
Separate Accounts, $23,000 ($18,000+$5,000), does not exceed the surplus 
held in the United States with respect to both of such Separate 
Accounts, $25,000 ($10,000+$15,000), under subdivision (v) of this 
subparagraph, no adjustment under section 819 must be made with respect 
to either of the Separate Accounts.
    (c) The excess of the minimum figure for the Regular Account 
($1,200,000) over the surplus held in the United States with respect to 
the Regular Account ($300,000) is equal to $900,000 
($1,200,000-$300,000). However, the company's overall excess as defined 
in subdivision (iv) of this subparagraph, is $898,000 
($1,223,000-$325,000). Under subdivision (iv) of this subparagraph the 
excess with respect to the Regular Account ($900,000) is limited to the 
amount of overall excess ($898,000). Thus, the amount of policy and 
other contract liability requirements with respect to T's Regular 
Account and the amount of required interest with respect to T's Regular 
Account (both computed without regard to section 819) shall each be 
reduced by an amount equal to the product of $898,000 and the current 
earnings rate computed only with respect to T's Regular Account.

    (c) Distributions to shareholders--(1) In general. In the case of a 
foreign life insurance company carrying on a life insurance business 
within the United States and taxable under section 802, section 
819(c)(1) provides alternative methods for determining the amount of 
distributions to shareholders for purposes of section 815 (relating to 
distributions to shareholders) and section 802(b)(3) (relating to life 
insurance company taxable income). Such a foreign life insurance company 
may elect (in the manner provided by subparagraph (4) of this paragraph) 
for each taxable year whichever of the alternative methods provided by 
section 819(c)(1) and this subparagraph it desires, and the method 
elected for any one taxable year shall be effective only with respect to 
the taxable year for which the election is made. Such alternative 
methods are:
    (i) The amount of the distributions to shareholders shall be the 
amount determined by multiplying the total amount of distributions to 
shareholders by the percentage which the minimum figure for the taxable 
year is of the excess of the assets of the company over the total 
insurance liabilities; or
    (ii) The amount of the distributions for shareholders shall be the 
amount determined by multiplying the total amount of distributions for 
shareholders by the percentage which the total insurance liabilities on 
United States business for the taxable year is of the total insurance 
liabilities of the company.
    (2) Definitions. For purposes of section 819(c)(1) and subparagraph 
(1) of this paragraph:
    (i) The term total amount of the distributions to shareholders means 
all distributions (within the meaning of section 815 and Sec. 1.815-2) 
by a foreign life insurance company to all of its shareholders whether 
or not in the United States;
    (ii) The term minimum figure for the taxable year means the amount 
determined under section 819(b)(2)(A) and paragraph (b)(2) of this 
section;
    (iii) The term assets of the company means all of the assets (as 
defined in section 805(b) (4) and paragraph (a) (4) of Sec. 1.805-5) of 
the foreign life insurance company whether or not in the United States 
(as of the end of the taxable year); and
    (iv) The term total insurance liabilities of the company means the 
total insurance liabilities (as defined in section 819(b)(2) and 
paragraph (b)(2) of this section) on all of its business whether or not 
in the United States (as of the end of the taxable year).
    (3) Illustration of principles. The provisions of section 819(c)(1) 
and subparagraphs (1) and (2) of this paragraph may be illustrated by 
the following examples:

    Example 1. For the taxable year 1958, T, a foreign life insurance 
company carrying on a life insurance business within the United States 
and taxable under section 802, has a minimum figure of $40,000, total 
amount of distributions to all shareholders (within the meaning of 
section 815) of $5,000, assets (as of the end of the year) of $500,000, 
total insurance liabilities (as of the end of the year) of $450,000, and 
total insurance liabilities on United States business (as of the end of 
the year) of $180,000. Based upon these facts, if T elects the method 
provided in section 819(c)(1)(A) and subparagraph (1)(i) of this

[[Page 599]]

paragraph, the amount of T's distributions to shareholders for the 
taxable year 1958 is $4,000, that is, $5,000 (the total amount of 
distributions to shareholders) multiplied by 80 percent (the percentage 
which the minimum figure for the taxable year, $40,000, is of $50,000, 
the excess of the assets of the company ($500,000) over the total 
insurance liabilities ($450,000)).
    Example 2. The facts are the same as in example 1, except that for 
the taxable year 1958, T elects the method provided in section 
819(c)(1)(B) and subparagraph (1)(ii) of this paragraph. Based upon 
these facts, the amount of T's distributions to shareholders for the 
taxable year 1958 is $2,000, that is, $5,000 (the total amount of 
distributions to shareholders) multiplied by 40 percent (the percentage 
which the total insurance liabilities on United States business 
($180,000) is of the total insurance liabilities of the company 
($450,000)).

    (4) Manner and effect of election. (i) The election provided by 
section 819(c)(1) shall be made in a statement attached to the foreign 
life insurance company's income tax return for any taxable year for 
which the company desires the election to apply. The return and 
statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for such taxable 
year. The statement shall indicate the method elected, the name and 
address of the taxpayer, and shall be signed by the taxpayer (or his 
duly authorized representative).
    (ii) An election made under section 819(c)(1) and this paragraph 
shall be effective only with respect to the taxable year for which the 
election is made. Thus, the company must make a new election for each 
taxable year for which it desires the election to apply. Once such 
election has been made for any taxable year it may not be revoked. 
However, for taxable years beginning prior to April 4, 1961, a company 
may revoke the election provided by section 819(c)(1) without obtaining 
consent from the Commissioner by filing, before July 4, 1961, a 
statement that the company desires to revoke such election. An amended 
return reflecting such revocation and the selection of the other 
percentage must accompany the statement for all taxable years for which 
returns have been filed with respect to such election.
    (5) Application of section 815. Once the amount of distributions to 
shareholders is determined under the provisions of section 819(c)(1) and 
this paragraph, the rules of section 815 (relating to distributions to 
shareholders) shall apply to the shareholders surplus account and the 
policyholders surplus account of a foreign stock life insurance company 
in the same manner as they would apply to a domestic stock life 
insurance company.
    (d) Distributions pursuant to certain mutualizations. Section 
819(c)(2) provides that for purposes of applying section 815(e) and 
paragraph (e) of Sec. 1.815-6 (relating to a special rule for certain 
mutualizations) in the case of a foreign life insurance company subject 
to tax under section 802:
    (1) The paid-in capital and paid-in surplus referred to in section 
815(e)(1)(A) of a foreign life insurance company is the portion of such 
capital and surplus determined by multiplying such amounts by the 
percentage selected for the taxable year under section 819(c)(1) and 
paragraph (c)(1) of this section; and
    (2) The excess referred to in section 815(e)(2)(A)(i) (without the 
adjustment provided by section 815(e)(2)(B)), is whichever of the 
following is the greater:
    (i) The minimum figure for 1958 determined under section 
819(b)(2)(A); or
    (ii) The surplus held in the United States (as defined in section 
819(b)(2)(B)) determined as of December 31, 1958.
    (e) No United States insurance business. Foreign life insurance 
companies not carrying on an insurance business within the United States 
shall not be taxable under part I, subchapter L, chapter 1 of the Code, 
but shall be taxable as other foreign corporations. See section 881 and 
the regulations thereunder.

[T.D. 6558, 26 FR 2791, Apr. 4, 1961; 26 FR 3276, Apr. 18, 1961, as 
amended by T.D. 6970, 33 FR 12044, Aug. 24, 1968]

    Editorial Note: For a determination with respect to the percentage 
to be used by foreign life insurance companies in computing income tax 
for the taxable year 1984 and the estimated tax for taxable year 1985, 
see 51 FR 883, Jan. 9, 1986.

[[Page 600]]

Mutual Insurance Companies (Other Than Life and Certain Marine Insurance 
Companies and Other Than Fire or Flood Insurance Companies Which Operate 
           on Basis of Perpetual Policies or Premium Deposits)



Sec. 1.821-1   Tax on mutual insurance companies other than life or marine or fire insurance companies subject to the tax imposed by section 831.

    (a) In general. (1) For taxable years beginning after December 31, 
1953, but before January 1, 1955, and ending after August 16, 1954, all 
mutual insurance companies, including foreign insurance companies 
carrying on an insurance business within the United States, not taxable 
under section 801 or 831 and not specifically exempt under the 
provisions of section 501(c)(15), are subject to the tax imposed by 
section 821 on their investment income or on their gross income, 
whichever tax is the greater, except interinsurers and reciprocal 
underwriters which are taxed only on their investment income. For the 
alternative tax, in lieu of the tax imposed by section 821 (a) or (b), 
where the net long-term capital gain for any taxable year exceeds the 
net short-term capital loss, see section 1201(a) and the regulations 
thereunder.
    (2) The taxable income of mutual insurance companies subject to the 
tax imposed by section 821 differs from the taxable income of other 
corporations. See section 821(a)(2) and section 822. Such companies are 
entitled, in computing mutual insurance company taxable income, to the 
deductions provided in part VIII (section 241 and following, except 
section 248), subchapter B, chapter 1 of the Code. The gross amount of 
income during the taxable year from interest, the deduction under 
section 822(c)(1) for wholly tax-exempt interest, and the deduction 
under section 242 for partially tax-exempt interest, are decreased by 
the appropriate amortization of premium and increased by the appropriate 
accrual of discount attributable to the taxable year on bonds, notes, 
debentures or other evidences of indebtedness held by a mutual insurance 
company subject to the tax imposed by section 821. See section 822(d)(2) 
and Sec. 1.822-3.
    (3) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 821 are 
applicable to the assessment and collection of the tax imposed by 
section 821 (a) or (b) and mutual insurance companies subject to the tax 
imposed by section 821 are subject to the same penalties as are provided 
in the case of returns and payment of income tax by other corporations. 
The return shall be on Form 1120M.
    (4) Foreign mutual insurance companies not carrying on an insurance 
business within the United States are not taxable under section 821 (a) 
or (b), but are taxable as other foreign corporations. See section 881.
    (5) Mutual insurance companies subject to the tax imposed by section 
821, except interinsurers or reciprocal underwriters, with mutual 
insurance company taxable income (computed without regard to the 
deduction provided in section 242 for partially tax-exempt interest) of 
over $3,000 or with gross amounts of income from interest, dividends, 
rents, and net premiums (minus dividends to policyholders and wholly 
tax-exempt interest) in excess of $75,000, are subject to a tax computed 
under section 821(a)(1) or section 821(a)(2) whichever is the greater. 
Interinsurers and reciprocal underwriters with mutual insurance company 
taxable income (computed without regard to the deduction provided in 
section 242 for partially tax-exempt interest) of over $50,000 are 
subject to a tax computed under section 821(b).
    (b) Rates of tax. (1) The normal tax under section 821(a)(1)(A) and 
821(b)(1), except as hereinafter indicated, is computed upon mutual 
insurance company taxable income for purposes of the normal tax at the 
rate of 30 percent.
    (2) The surtax under section 821(a)(1)(B) and 821(b)(2), except as 
hereinafter indicated, is computed on that portion of the mutual 
insurance company taxable income for purposes of the surtax in excess of 
$25,000 at the rate of 22 percent. The tax under section 821(a)(2), 
except as hereinafter indicated, is 1 percent of the gross amount of 
income from interest, dividends, rents, and net premiums, minus 
dividends to policyholders and minus wholly tax-exempt interest.

[[Page 601]]

    (3) Under section 821(a)(1)(A) companies with mutual insurance 
company taxable income for purposes of the normal tax of over $3,000 and 
not over $6,000 pay a normal tax, at a specified rate, on that portion 
of such income in excess of $3,000. The rate applicable in computing the 
normal tax of such companies is 60 percent. Under section 821(a)(2) 
companies with gross amounts of income from interest dividends, rents, 
and net premiums, minus dividends to policyholders and minus wholly tax-
exempt interest, of over $75,000 and not over $150,000 pay a tax equal 
to 2 percent of that portion in excess of $75,000.
    (4) Under section 821(b)(1) interinsurers and reciprocal 
underwriters with mutual insurance company taxable income for purposes 
of the normal tax of over $50,000 and not over $100,000 pay a normal tax 
computed on that portion of such income in excess of $50,000 at the rate 
of 60 percent. Under section 821(b)(2) interinsurers and reciprocal 
underwriters with mutual insurance company taxable income for purposes 
of the surtax of over $50,000 and not over $100,000 pay a surtax, at the 
rate of 33 percent, on that portion of such income in excess of $50,000.
    (5) Section 821(c) provides for an adjustment of the amount computed 
under section 821(a)(1), section 821(a)(2), and section 821(b) where the 
gross amount received during the taxable year from interest, dividends, 
rents, and premiums (including deposits and assessments) is over $75,000 
and less than $125,000. The adjustment reduces the tax otherwise 
computed under those sections to an amount which bears the same 
proportion to such tax as the excess over $75,000 bears to $50,000.
    (c) Application. The application of section 821 (a) to (c) 
inclusive, may be illustrated by the following examples:

    Example 1. The W Company, a mutual casualty insurance company, for 
the calendar year 1954, has mutual insurance company taxable income for 
purposes of the surtax of $5,500 and, due to partially tax-exempt 
interest of $800, has income for purposes of the normal tax of $4,700. 
The gross amount of income of the W Company from interest, dividends, 
rents and net premiums, minus dividends to policyholders and wholly tax-
exempt interest, is $150,000. Its normal tax under section 821(a)(1) for 
the calendar year 1954 is 60 percent of $1,700 ($4,700 minus $3,000) or 
$1,020, since its income subject to normal tax is not over $6,000. It is 
not liable for surtax for the calendar year 1954 as its mutual insurance 
company taxable income for purposes of the surtax does not exceed 
$25,000. It has no surtax and, therefore, its total tax under section 
821(a)(1)(A) is the normal tax of $1,020. The tax under section 
821(a)(2) is 2 percent of $75,000 ($150,000-$75,000), or $1,500. Since 
the tax under section 821(a)(2) exceeds the tax under section 821(a)(1), 
the tax under section 821 is $1,500, namely, that imposed by section 
821(a)(2).
    Example 2. If in example 1 the income for purposes of the normal tax 
were not over $3,000, the income for purposes of the surtax were not 
over $25,000, the gross amount received from interest, dividends, rents, 
and premiums (including deposits and assessments) were $90,000, and the 
gross amount of income from interest, dividends, rents, and net 
premiums, minus dividends to policyholders and wholly tax-exempt 
interest, were $70,000, the W Company would be required to file an 
income tax return but due to section 821(a) no income tax would be 
imposed.
    Example 3. The X Company, a mutual casualty insurance company, for 
the calendar year 1954 has mutual insurance company taxable income for 
surtax purposes of $28,000 and, due to partially tax-exempt interest of 
$5,000, has income for normal tax purposes of $23,000. The gross amount 
of income of the X Company from interest, dividends, rents, and net 
premiums, minus dividends to policyholders and wholly tax-exempt 
interest, is $1,200,000. Under section 821(a)(1) its normal tax for the 
calendar year 1954 is 30 percent of $23,000, or $6,900, and the surtax 
is 22 percent of $3,000 ($28,000-$25,000), or $660. The combined tax 
under section 821(a)(1) is $7,560 ($6,900 plus $660). The tax under 
section 821(a)(2) is 1 percent of $1,200,000, or $12,000. Since the tax 
under section 821(a)(2) exceeds the tax under section 821(a)(1), the tax 
under section 821(a) is $12,000, namely, that imposed by section 
821(a)(2).
    Example 4. The Y Company, a mutual fire insurance company subject to 
the tax imposed by section 821 for the calendar year 1954, has mutual 
insurance company taxable income for purposes of the surtax of $35,000 
and, due to partially tax-exempt interest of $5,000, has income for 
purposes of the normal tax of $30,000. The gross amount received from 
interest, dividends, rents and premiums (including deposits and 
assessments) is $120,000, and the gross amount of income from interest, 
dividends, rents, and net premiums, minus dividends to policyholders and 
wholly tax-exempt interest, is $100,000. Under section 821(a)(1), 
without application of section 821(c), the normal tax would be 30 
percent of $30,000, or $9,000, since this is less

[[Page 602]]

than $16,200, 60 percent of $27,000 (excess of $30,000 over $3,000); and 
the surtax would be 22 percent of $10,000 (excess of $35,000 over 
$25,000), or $2,200. The combined tax of $11,200 ($9,000 plus $2,200) 
would then be reduced by applying section 821(c), since the gross 
receipts are between $75,000 and $125,000. The tax under section 
821(a)(1), as thus adjusted, would be 90 percent of $11,200, or $10,080, 
since $45,000 (excess of $120,000 over $75,000) is 90 percent of 
$50,000. Under section 821(a)(2), without reference to section 821(c), 
the tax is 2 percent of $25,000 (excess of $100,000 over $75,000), or 
$500, since this is less than $1,000, 1 percent of $100,000. Applying 
section 821(c) reduces this to $450, or 90 percent of $500. Since 
$10,080, the tax under section 821(a)(1), as adjusted, exceeds $450, the 
tax under section 821(a)(2), as adjusted, the tax under section 
821(a)(1), as adjusted, is applicable. The Y Company would accordingly 
pay a combined normal taxing and surtax of $10,080.
    Example 5. The Z Exchange, an interinsurer, for the calendar year 
1954 has mutual insurance company taxable income for purposes of the 
surtax of $60,000 and, due to partially tax-exempt interest of $12,000, 
has income for purposes of the normal tax of $48,000. The gross amount 
received from interest, dividends, rents, and premiums (including 
deposits and assessments) is $2,700,000. The Z Exchange is not liable 
for normal tax under section 821(b)(1) for the calendar year 1954 as its 
mutual insurance company taxable income for purposes of the normal tax 
does not exceed $50,000. Its surtax is 33 percent of $10,000 ($60,000 
minus $50,000), or $3,300, since that amount is less than $7,700, 22 
percent of $35,000 (excess of $60,000 over $25,000). Since the Z 
Exchange has no normal tax, is not subject to the tax imposed by section 
821(a)(2), and is not entitled to the adjustment provided in section 
821(c), its total tax under section 821(a) is $3,300.



Sec. 1.821-2  Taxable years affected.

    Section 1.821-1 is applicable only to taxable years beginning after 
December 31, 1953, but before January 1, 1955, and ending after August 
16, 1954, and all references to sections of part II, subchapter L, 
chapter 1 of the Code are to the Internal Revenue Code of 1954, before 
amendments. Section 1.821-3 is applicable only to taxable years 
beginning after December 31, 1954, but before January 1, 1963, and all 
references to sections of part II, subchapter L, chapter 1 of the Code 
are to the Internal Revenue Code of 1954, as amended by the Life 
Insurance Company Tax Act for 1955 (70 Stat. 36). Sections 1.821-4 and 
1.821-5 are applicable only to taxable years beginning after December 
31, 1962, and all references to sections of parts II and III, subchapter 
L, chapter 1 of the Code are to sections of the Internal Revenue Code of 
1954 as amended by section 8 of the Revenue Act of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11110, Oct. 17, 1963]



Sec. 1.821-3  Tax on mutual insurance companies other than life or marine or fire insurance companies subject to the tax imposed by section 831.

    (a) In general. (1) For taxable years beginning after December 31, 
1954, all mutual insurance companies, including foreign insurance 
companies carrying on an insurance business within the United States, 
not taxable under section 802 or 831 and not specifically exempt under 
the provisions of section 501(c)(15), are subject to the tax imposed by 
section 821 on their investment income or on their gross income, 
whichever tax is the greater, except interinsurers and reciprocal 
underwriters which are taxed only on their investment income. For the 
alternative tax, in lieu of the tax imposed by section 821 (a) or (b), 
where the net long-term capital gain for any taxable year exceeds the 
net short-term capital loss, see section 1201(a) and the regulations 
thereunder.
    (2) The taxable income of mutual insurance companies subject to the 
tax imposed by section 821 differs from the taxable income of other 
corporations. See section 821(a)(2) and section 822. Such companies are 
entitled, in computing mutual insurance company taxable income, to the 
deductions provided in part VIII (section 241 and following, except 
section 248), subchapter B, chapter 1 of the Code. The gross amount of 
income during the taxable year from interest, the deduction under 
section 822(c)(1) for wholly tax-exempt interest, and the deduction 
under section 242 for partially tax-exempt interest, are decreased by 
the appropriate amortization of premium and increased by the appropriate 
accrual of discount attributable to the taxable year on bonds, notes, 
debentures or other evidences of indebtedness held by a mutual insurance 
company subject to the tax imposed by section 821. See section 822(d)(2) 
and Sec. 1.822-7. However, for taxable years beginning after May 31, 
1960,

[[Page 603]]

only the accrual of discount relating to issue discount will increase 
the deduction for wholly tax-exempt interest. See section 103. In the 
case of any such evidence of indebtedness, adjustment shall be made to 
basis in the same manner as that made by life insurance companies under 
section 1016(a)(17) and the regulations thereunder.
    (3) All provisions of the Internal Revenue Code and of the 
regulations in this part not inconsistent with the specific provisions 
of section 821 are applicable to the assessment and collection of the 
tax imposed by section 821 (a) or (b) and mutual insurance companies 
subject to the tax imposed by section 821 are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations. The return shall be on Form 1120M.
    (4) Foreign mutual insurance companies not carrying on an insurance 
business within the United States are not taxable under section 821 (a) 
or (b), but are taxable as other foreign corporations. See section 881.
    (5) Mutual insurance companies subject to the tax imposed by section 
821, except interinsurers or reciprocal underwriters, with mutual 
insurance company taxable income (computed without regard to the 
deduction provided in section 242 for partially tax-exempt interest) of 
over $3,000 or with gross amounts of income during the taxable year from 
the items described in section 822(b) (other than paragraph (1)(D) 
thereof) and net premiums (minus dividends to policyholders and wholly 
tax-exempt interest) in excess of $75,000, are subject to a tax computed 
under section 821(a)(1) or section 821(a)(2) whichever is the greater. 
Interinsurers and reciprocal underwriters with mutual insurance company 
taxable income (computed without regard to the deduction provided in 
section 242 for partially tax-exempt interest) of over $50,000 are 
subject to a tax computed under section 821(b).
    (b) Rates of tax. (1) For taxable years beginning before July 1, 
1963, the normal tax under section 821(a)(1)(A) and 821(b)(1), except as 
hereinafter indicated, is computed upon mutual insurance company taxable 
income for purposes of the normal tax at the rate of 30 percent.
    (2) The surtax under section 821(a)(1)(B) and 821(b)(2), except as 
hereinafter indicated, is computed on that portion of the mutual 
insurance company taxable income for the purposes of the surtax in 
excess of $25,000 at the rate of 22 percent. The tax under section 
821(a)(2), except as hereinafter indicated, is 1 percent of the gross 
amount of income during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and minus wholly tax-exempt interest.
    (3) For taxable years beginning before July 1, 1963, under section 
821(a)(1)(A) companies with mutual insurance company taxable income for 
purposes of the normal tax of over $3,000 and not over $6,000 pay a 
normal tax, at a specified rate, on that portion of such income in 
excess of $3,000. The rate applicable in computing the normal tax of 
such companies is 60 percent. Under section 821(a)(2) companies with 
gross amounts of income during the taxable year from the items described 
in section 822(b) (other than paragraph (1)(D) thereof) and net 
premiums, minus dividends to policyholders and minus wholly tax-exempt 
interest, of over $75,000 and not over $150,000 pay a tax equal to 2 
percent of that portion in excess of $75,000.
    (4) For taxable years beginning before July 1, 1963, under section 
821(b)(1) interinsurers and reciprocal underwriters with mutual 
insurance company taxable income for purposes of the normal tax of over 
$50,000 and not over $100,000 pay a normal tax computed on that portion 
of such income in excess of $50,000 at the rate of 60 percent. Under 
section 821(b)(2) interinsurers and reciprocal underwriters with mutual 
insurance company taxable income for purposes of the surtax of over 
$50,000 and not over $100,000 pay a surtax, at the rate of 33 percent, 
on that portion of such income in excess of $50,000.
    (5) Section 821(c) provides for an adjustment of the amount computed 
under section 821(a)(1), section 821(a)(2), and section 821(b) where the 
gross amount received during the taxable

[[Page 604]]

year from the items described in section 822(b) (other than paragraph 
(1)(D) thereof) and premiums (including deposits and assessments) is 
over $75,000 and less than $125,000. The adjustment reduces the tax 
otherwise computed under those sections to an amount which bears the 
same proportion to such tax as the excess over $75,000 bears to $50,000.
    (c) Application. The application of section 821 (a) to (c) 
inclusive, may be illustrated by the following examples:

    Example 1. The W Company, a mutual casualty insurance company, for 
the calendar year 1958, has mutual insurance company taxable income for 
purposes of the surtax of $5,500 and, due to partially tax-exempt 
interest of $800, has income for purposes of the normal tax of $4,700. 
The gross amount of income of the W Company from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and wholly tax-exempt interest, is 
$150,000. Its normal tax under section 821(a)(1) for the calendar year 
1958 is 60 percent of $1,700 ($4,700 minus $3,000) or $1,020, since its 
income subject to normal tax is not over $6,000. It is not liable for 
surtax for the calendar year 1958 as its mutual insurance company 
taxable income for purposes of the surtax does not exceed $25,000. It 
has no surtax and, therefore, its total tax under section 821(a)(1)(A) 
is the normal tax of $1,020. The tax under section 821(a)(2) is 2 
percent of $75,000 ($150,000- $75,000), or $1,500. Since the tax under 
section 821(a)(2) exceeds the tax under section 821(a)(1), the tax under 
section 821 is $1,500, namely, that imposed by section 821(a)(2).
    Example 2. If in the above example the income for purposes of the 
normal tax were not over $3,000, the income for purposes of the surtax 
were not over $25,000, the gross amount received from interest, 
dividends, rents, and premiums (including deposits and assessments) were 
$90,000, and the gross amount of income from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and net premiums, 
minus dividends to policyholders and wholly tax-exempt interest were 
$70,000, the W Company would be required to file an income tax return 
but due to section 821(a) no income tax would be imposed.
    Example 3. The X Company, a mutual casualty insurance company, for 
the calendar year 1958, has mutual insurance company taxable income for 
surtax purposes of $28,000 and, due to partially tax-exempt interest of 
$5,000, has income for normal tax purposes of $23,000. The gross amount 
of income of the X Company received during the taxable year from the 
items described in section 822(b) (other than paragraph (1)(D) thereof) 
and net premiums, minus dividends to policyholders and wholly tax-exempt 
interest, is $1,200,000. Under section 821(a)(1) its normal tax for the 
calendar year 1958 is 30 percent of $23,000, or $6,900, and the surtax 
is 22 percent of $3,000 ($28,000-$25,000), or $660. The combined tax 
under section 821(a)(1) is $7,560 ($6,900 plus $660). The tax under 
section 821(a)(2) is 1 percent of $1,200,000, or $12,000. Since the tax 
under section 821(a)(2) exceeds the tax under section 821(a)(1), the tax 
under section 821(a) is $12,000, namely, that imposed by section 
821(a)(2).
    Example 4. The Y Company, a mutual fire insurance company subject to 
the tax imposed by section 821 for the calendar year 1958, has mutual 
insurance company taxable income for purposes of the surtax of $35,000 
and, due to partially tax-exempt interest of $5,000, has income for 
purposes of the normal tax of $30,000. The gross amount received during 
the taxable year from the items described in section 822(b) (other than 
paragraph (1)(D) thereof) and premiums (including deposits and 
assessments) is $120,000, and the gross amount of income from interest, 
dividends, rents, and net premiums, minus dividends to policyholders and 
wholly tax-exempt interest, is $100,000. Under section 821(a)(1), 
without application of section 821(c), the normal tax would be 30 
percent of $30,000, or $9,000, since this is less than $16,200, 60 
percent of $27,000 (excess of $30,000 over $3,000); and the surtax would 
be 22 percent of $10,000 (excess of $35,000 over $25,000), or $2,200. 
The combined tax of $11,200 ($9,000 plus $2,200) would then be reduced 
by applying section 821(c), since the gross receipts are between $75,000 
and $125,000. The tax under section 821(a)(1), as thus adjusted, would 
be 90 percent of $11,200, or $10,080, since $45,000 (excess of $120,000 
over $75,000) is 90 percent of $50,000. Under section 821(a)(2), without 
reference to section 821(c), the tax is 2 percent of $25,000 (excess of 
$100,000 over $75,000), or $500, since this is less than $1,000, 1 
percent of $100,000. Applying section 821(c) reduces this to $450, or 90 
percent of $500. Since $10,080, the tax under section 821(a)(1), as 
adjusted, exceeds $450, the tax under section 821(a)(2), as adjusted, 
the tax under section 821(a)(1), as adjusted, is applicable. The Y 
Company would accordingly pay a combined normal tax and surtax of 
$10,080.
    Example 5. The Z Exchange, an interinsurer, for the calendar year 
1958 has mutual insurance company taxable income for purposes of the 
surtax of $60,000 and, due to partially tax-exempt interest of $12,000, 
has income for purposes of the normal tax of $48,000. The gross amount 
received during the taxable year from the items described in section 
822(b) (other than paragraph (1)(D) thereof) and premiums (including 
deposits and assessments) is $2,700,000. The Z Exchange is not liable 
for normal tax under

[[Page 605]]

section 821(b)(1) for the calendar year 1958 as its mutual insurance 
company taxable income for purposes of the normal tax does not exceed 
$50,000. Its surtax is 33 percent of $10,000 ($60,000 minus $50,000), or 
$3,300, since that amount is less than $7,700, 22 percent of $35,000 
(excess of $60,000 over $25,000). Since the Z Exchange has no normal 
tax, is not subject to the tax imposed by section 821(a)(2), and is not 
entitled to the adjustment provided in section 821(c), its total tax 
under section 821(b) is $3,300.

[T.D. 6610, 27 FR 8718, Aug. 31, 1962]



Sec. 1.821-4  Tax on mutual insurance companies other than life insurance companies and other than fire, flood, or marine insurance companies, subject to tax 
          imposed by section 831.

    (a) In general--(1) Tax imposed. (i) For taxable years beginning 
after December 31, 1962, all mutual insurance companies, including 
foreign insurance companies carrying on an insurance business within the 
United States, not taxable under section 802 or 831, and not 
specifically exempt under the provisions of section 501(c)(15), are 
subject either to the tax imposed by section 821(a) on mutual insurance 
company taxable income or, in the case of certain small companies, to 
the tax imposed by section 821(c) on taxable investment income. The 
determination of whether a mutual insurance company is taxable under 
section 821 (a) or (c) for the taxable year is dependent upon the gross 
amount received by the company during such taxable year from the items 
described in section 822(b) (other than paragraph (1)(D) thereof) and 
premiums (including deposits and assessments). If such gross amount 
received exceeds $150,000, but does not exceed $500,000 for the taxable 
year, the company is subject to the tax imposed by section 821(c) on 
taxable investment income, unless (a) the company elects under section 
821(d) in the manner provided in paragraph (f) of this section to be 
subject to the tax imposed by section 821(a), or (b) there is a balance 
in its protection against loss account at the beginning of the taxable 
year. A company having a gross amount received in excess of $500,000 is 
subject to the tax imposed by section 821(a). For exemption from income 
tax of companies having a gross amount received not in excess of 
$150,000, see section 501(c)(15). For the alternative tax, in lieu of 
the tax imposed by section 821 (a) or (c), where the net long-term 
capital gain for any taxable year exceeds the net short-term capital 
loss, see section 1201(a) and the regulations thereunder. For the 
definition of an insurance company, see paragraph (a) of Sec. 1.801-3. 
    (ii) The term ``premiums'' as used in section 821 and this section 
has the same meaning as in section 501(c)(15) and Sec. 1.501(c)(15)-1, 
and means the total amount of the premiums and other consideration 
provided in the insurance contract without any deduction for 
commissions, return premiums, reinsurance, dividends to policyholders, 
dividends left on deposit with the company, discounts on premiums paid 
in advance, interest applied in reduction of premiums (whether or not 
required to be credited in reduction of premiums under the terms of the 
contract), or any other item of similar nature. Such term includes 
advance premiums, premiums deferred and uncollected and premiums due and 
unpaid, deposits, fees, assessments, and consideration in respect of 
assuming liabilities under contracts not issued by the taxpayer (such as 
a payment or transfer of property in an assumption reinsurance 
transaction), but does not include amounts received from other insurance 
companies for losses paid under reinsurance contracts.
    (2) Tax base. The taxable income of mutual insurance companies 
taxable under section 821 differs from the taxable income of other 
corporations. See sections 821(b) and 822. Mutual insurance companies 
have special items of income and special deductions not provided for 
other corporations. See, for example, sections 821(b)(1)(C), 822(d), 
823(b), 824(a), and 825(a). Thus, the computation of mutual insurance 
company taxable income for a company taxable under section 821(a), and 
the computation of taxable investment income for a company taxable under 
section 821(c), must be made in strict accordance with the provisions of 
part II of subchapter L of the Code.
    (3) Applicability of other provisions. All provisions of the Code 
and of the regulations in this part not inconsistent with the specific 
provisions of part II of

[[Page 606]]

subchapter L of the Code are applicable to the assessment and collection 
of the tax imposed by section 821 (a) or (c), and mutual insurance 
companies subject to the tax imposed by section 821 are subject to the 
same penalties as are provided in the case of returns and payment of 
income tax by other corporations. The return shall be on Form 1120M.
    (4) Certain foreign companies. Foreign mutual insurance companies 
(other than a life insurance company and other than a fire, flood, or 
marine insurance company subject to the tax imposed by section 831) not 
carrying on an insurance business within the United States are not 
taxable under section 821 (a) or (c), but are taxable as other foreign 
corporations. See section 881.
    (b) Rates of tax imposed by section 821(a)--(1) Normal tax. For 
taxable years beginning before January 1, 1964, the normal tax imposed 
under section 821(a) is the lesser of 30 percent of mutual insurance 
company taxable income, or 60 percent of the amount by which mutual 
insurance company taxable income exceeds $6,000. In the case of taxable 
years beginning after December 31, 1963, the normal tax is imposed at 
the rate of 22 percent of mutual insurance company taxable income, or 44 
percent of the amount by which mutual insurance company taxable income 
exceeds $6,000, whichever is the lesser. For example, a company subject 
to tax under section 821(a) will file a return but will pay no normal 
tax if mutual insurance company taxable income does not exceed $6,000. 
When mutual insurance company taxable income exceeds $6,000 but does not 
exceed $12,000, the company will pay a normal tax equal to 44 percent 
(60 percent in the case of taxable years beginning before Jan. 1, 1964), 
of the amount by which mutual insurance company taxable income exceeds 
$6,000. When mutual insurance company taxable income exceeds $12,000, 
the company will pay normal tax at the rate of 22 percent (30 percent in 
the case of taxable years beginning before Jan. 1, 1964), of such 
income.
    (2) Surtax--(i) Taxable years beginning before January 1, 1964. For 
taxable years beginning before January 1, 1964, companies taxable under 
section 821(a) are subject to a surtax equal to 22 percent of so much of 
their mutual insurance company taxable income (computed without regard 
to the deduction provided in section 242 for partially tax-exempt 
interest) as exceeds $25,000. In the case of an interinsurer or 
reciprocal underwriter electing to be subject to the limitation provided 
in section 826(b), the surtax applies to any increase in mutual 
insurance company taxable income attributable to such election, without 
regard to the $25,000 surtax exemption otherwise provided by this 
subparagraph, and without regard to whether the company is liable for 
any normal tax under subparagraph (1) of this paragraph. See section 
826(f) and Sec. 1.826-2.
    (ii) Taxable years beginning after December 31, 1963. For taxable 
years beginning after December 31, 1963, companies taxable under section 
821(a) are subject to a surtax at the rates and with the exemptions 
provided in section 11(c) on their mutual insurance company taxable 
income. In the case of an interinsurer or reciprocal underwriter 
electing to be subject to the limitation provided in section 826(b), the 
surtax applies to any increase in mutual insurance company taxable 
income attributable to such election, without regard to the surtax 
exemption otherwise provided by section 11(d), and without regard to 
whether the company is liable for any normal tax under section 821(a)(1) 
and subparagraph (1) of this paragraph. See section 826(f) and 
Sec. 1.826-2.
    (c) Mutual insurance company taxable income defined. The tax imposed 
by section 821(a) with respect to any taxable year is computed upon 
mutual insurance company taxable income for the taxable year. Section 
821(b) provides that in the case of a mutual insurance company subject 
to the tax imposed by section 821(a), mutual insurance company taxable 
income means the amount by which:
    (1) The sum of:
    (i) The taxable investment income (as defined in section 822(a)(1) 
and paragraph (a)(1) of Sec. 1.822-8).
    (ii) The statutory underwriting income (as defined in section 
823(a)(1) and paragraph (b)(1) of Sec. 1.823-6), and

[[Page 607]]

    (iii) The amounts required by section 824(d) and paragraph (b)(3) of 
Sec. 1.824-1 to be subtracted from the protection against loss account, 
exceeds.
    (2) The sum of:
    (i) The investment loss (as defined in section 822(a)(2) and 
paragraph (a)(2) of Sec. 1.822-8),
    (ii) The statutory underwriting loss (as defined in section 
823(a)(2) and paragraph (b)(2) of Sec. 1.823-6), and
    (iii) The unused loss deduction provided by section 825(a) and 
paragraph (a) of Sec. 1.825-1.

If for any taxable year the amount determined under subparagraph (2) of 
this paragraph equals or exceeds the amount determined under 
subparagraph (1) of this paragraph, the mutual insurance company taxable 
income for such year shall be zero.
    (d) Examples. The application of the tax imposed by section 821(a) 
may be illustrated by the following examples:

    Example 1. (a) M, a mutual casualty insurance company, for the 
calendar year 1963 has gross receipts from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) in excess of $500,000, and 
therefore is subject to the tax imposed by section 821(a). M's taxable 
investment income, computed under section 822, is $30,000 and its 
statutory underwriting income, computed under section 823, is $15,000. M 
subtracts $3,000 from its protection against loss account in accordance 
with the computation made under section 824(d). M has no unused loss 
deduction. M received no partially tax exempt interest. If M is not 
subject to section 826, its mutual insurance company taxable income for 
the taxable year 1963 is $48,000, computed as follows:

(1) Taxable investment income.................................   $30,000
(2) Statutory underwriting income.............................    15,000
(3) Subtractions from protection against loss account.........     3,000
                                                               ---------
(4) Total income items........................................    48,000
                                                               ---------
(5) Investment loss...........................................         0
                                                               ---------
(6) Statutory underwriting loss...............................         0
                                                               ---------
(7) Unused loss deduction.....................................         0
                                                               ---------
(8) Total loss items..........................................         0
                                                               =========
(9) Mutual insurance company taxable income (item (4) minus             
 item (8))....................................................    48,000
                                                                        

    (b) Since M's mutual insurance company taxable income is in excess 
of $12,000, M will pay normal tax on its mutual insurance company 
taxable income at a rate of 30 percent. In addition, since M's mutual 
insurance company taxable income exceeds $25,000, M will pay surtax on 
such excess at a rate of 22 percent. M's total tax liability for the 
taxable year 1963 is $19,460, computed as follows:

(1) Mutual insurance company taxable income as computed in              
 item (a)(9)..................................................   $48,000
(2) Normal tax; 30 percent of mutual insurance company taxable          
 income.......................................................    14,400
(3) Surtax exemption..........................................    25,000
(4) Mutual insurance company taxable income subject to the              
 surtax (item (1) minus item (3)).............................    23,000
(5) Surtax: 22 percent of mutual insurance company taxable              
 income subject to the surtax.................................     5,060
(6) Total tax (item (2) plus item (5))........................    19,460
                                                                        

    Example 2. If in example 1, M's mutual insurance company taxable 
income for 1963 had been in excess of $6,000 but not in excess of 
$12,000, M would pay normal tax in an amount equal to 60 percent of the 
amount by which such income exceeded $6,000. Thus, if M had mutual 
insurance company taxable income of $11,000, M's total tax liability for 
the taxable year 1963 would be $3,000, computed as follows:

(1) Mutual insurance company taxable income...................   $11,000
(2) Mutual insurance company taxable income in excess of                
 $6,000 ($11,000 minus $6,000)................................     5,000
(3) 30 percent of item (1)....................................     3,800
(4) 60 percent of item (2)....................................     3,000
(5) Normal tax (lesser of items (3) or (4))...................     3,000
(6) Surtax exemption..........................................    25,000
                                                                        

Since the surtax exemption exceeds the mutual insurance company taxable 
income for purposes of the surtax, there is no surtax liability. Since 
the normal tax under section 821(a) is the lesser of 30 percent of 
mutual insurance company taxable income or 60 percent of the amount by 
which such income exceeds $6,000, M's normal tax (and total income tax 
liability) is $3,000. If M's mutual insurance company taxable income was 
not in excess of $6,000, M would be required to file a return, but would 
not be liable for any normal tax, since, in such a case, 60 percent of 
M's mutual insurance company taxable income in excess of $6,000 would be 
zero.
    Example 3. Assume the same income as in example 1 in the 1965 
calendar year and that M is not a corporation to which section 1561 
(with respect to certain controlled corporations) applies. Since M's 
mutual insurance company taxable income is in excess of $12,000, M will 
pay normal tax on its mutual insurance company taxable income at a rate

[[Page 608]]

of 22 percent. In addition, since M's mutual insurance company taxable 
income exceeds the surtax exemption provided in section 11(d) of 
$25,000, M will pay a surtax on such excess at the rate provided in 
section 11(c), 26 percent. M's total liability for the taxable year 1964 
is $16,540, computed as follows:

(1) Mutual insurance company taxable income as computed in              
 example (1)..................................................   $48,000
(2) Normal tax: 22 percent of mutual insurance company taxable          
 income for normal tax purposes...............................    10,560
(3) Surtax exemption provided by section 11(d)................    25,000
(4) Mutual insurance company taxable income subject to the              
 surtax (item (1) minus item (3)).............................    23,000
(5) Surtax: at rates provided in section 11(c): 26 percent of           
 mutual insurance company taxable income subject to the surtax     5,980
(6) Total tax (item (2) plus item (5))........................    16,540
                                                                        

    (e) Alternative tax for certain small mutual insurance companies--
(1) In general. (i) Section 821(c) provides an alternative tax for 
certain small mutual insurance companies. This alternative tax, which is 
in lieu of the tax imposed by section 821(a), is imposed on taxable 
investment income (as defined in section 822(a)(1) and paragraph (a)(1) 
of Sec. 1.822-8) and consists of a normal tax and a surtax. The tax 
provided by section 821(c) is imposed on every mutual insurance company 
(other than a life insurance company and other than a fire, flood, or 
marine insurance company subject to the tax imposed by section 831) 
which received during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) a gross amount in excess of 
$150,000 but not in excess of $500,000, except a company which has 
properly elected under section 821(d) and paragraph (f) of this section 
to be subject to the tax imposed by section 821(a), or a company which 
has a balance in its protection against loss account at the beginning of 
the taxable year.
    (ii) Any company which would be taxable under section 821(c) but for 
the presence of an amount in its protection against loss account at the 
beginning of the taxable year may elect to subtract the balance from 
such account. See section 824(d)(5) and Sec. 1.824-3. If such an 
election is made in such a case, the company shall not be subject to the 
tax imposed by section 821(a), but shall be subject to the tax imposed 
by section 821(c).
    (2) Rates of tax imposed by section 821(c)--(i) Normal tax. The 
normal tax for taxable years beginning before January 1, 1964, is the 
lesser of 30 percent of taxable investment income or 60 percent of the 
amount by which taxable investment income exceeds $3,000. For taxable 
years beginning after December 31, 1963, the normal tax is imposed at 
the rate of 22 percent of taxable investment income, or 44 percent of 
the amount by which taxable investment income exceeds $3,000, whichever 
is the lesser. Thus, a company subject to tax under section 821(c) will 
file a return but will pay no tax if for the taxable year its taxable 
investment income does not exceed $3,000; or will pay a normal tax equal 
to 44 percent (60 percent in the case of taxable years beginning before 
Jan. 1, 1964), of taxable investment income in excess of $3,000 when 
such income exceeds $3,000 but does not exceed $6,000. When taxable 
investment income exceeds $6,000, the normal tax is imposed at the rate 
of 22 percent (30 percent in the case of taxable years beginning before 
Jan. 1, 1964) of such income.
    (ii) Surtax. For taxable years beginning before January 1, 1964, a 
surtax is imposed at the rate of 22 percent of taxable investment income 
(computed without regard to the deduction provided in section 242 for 
partially tax-exempt interest) in excess of $25,000. For taxable years 
beginning after December 31, 1963, a surtax is imposed at the rate 
provided in section 11(c) on taxable investment income in excess of the 
surtax exemption provided in section 11(d).
    (f) Election to be taxed under section 821(a)--(1) In general. 
Section 821(d) provides that any mutual insurance company taxable under 
section 821(c) may elect, in the manner provided by subparagraph (3) of 
this paragraph, to be taxed under section 821(a).
    (2) Scope of election. Except as otherwise provided herein, an 
election made under section 821(d) and this paragraph to be taxable 
under section 821(a) shall be binding for the taxable year for

[[Page 609]]

which made and for all succeeding taxable years unless the Commissioner 
consents to a revocation of such election. If for any taxable year the 
gross amount received from the items described in section 822(b) (other 
than paragraph (1)(D) thereof) and premiums (including deposits and 
assessments) does not exceed $150,000, a company's prior election made 
under section 821(d) to be taxable under section 821(a) will 
automatically terminate and any balance in the protection against loss 
account will be taken into account for the preceding taxable year. (See 
section 824(d)(4) and Sec. 1.824-2 for automatic termination of 
protection against loss account if company is not subject to the tax 
imposed by section 821(a).) If for any taxable year thereafter the gross 
amount received exceeds $150,000 but does not exceed $500,000, the 
company shall be taxable under section 821(c) unless it makes a new 
election to be taxable under section 821(a). If a company subject to tax 
under section 821(c) for a taxable year elects under section 821(d) and 
this section to be taxed under section 821(a) and, in a subsequent 
taxable year, the gross receipts of such company exceed $500,000, the 
election made for such earlier taxable year shall be considered as 
continuing in effect. Thus, such a company will continue to be taxable 
under section 821(a) notwithstanding that its gross receipts 
subsequently fall below $500,000 (so long as they do not fall below 
$150,000) unless the Commissioner consents to a revocation of the prior 
election. Whether revocation is permissible in any case will depend on 
the facts and circumstances of the particular case, but in no case will 
revocation be granted in the absence of a showing that the election 
creates an undue burden or material hardship on the company due to a 
substantial change in the character of its operations.
    (3) Time and manner of making election. The election provided by 
section 821(d) shall be made in a statement attached to the company's 
income tax return for the first taxable year for which the election is 
to apply. The statement shall include the name and address of the 
taxpayer, shall be signed by the taxpayer (or its duly authorized 
representative), and shall be filed not later than the date prescribed 
by law (including extensions thereof) for filing the return for such 
taxable year.
    (g) Examples. The application of the tax imposed by section 821(c) 
may be illustrated by the following examples:

    Example 1. M, a mutual casualty insurance company, for the calendar 
year 1963 has a gross amount received from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) of $400,000. Since M's gross amount 
received exceeds $150,000, but does not exceed $500,000, M is subject to 
the tax imposed by section 821(c) on taxable investment income unless it 
elects to be subject to the tax imposed on mutual insurance company 
taxable income by section 821(a). M computes its taxable investment 
income under section 822 to be $35,000. In computing taxable investment 
income, M deducted $2,000 of partially tax-exempt interest under section 
242. If M does not make an election to be taxed under section 821(a), 
its total tax liability for the taxable year 1963 is $13,140 computed as 
follows:

(1) Taxable investment income as computed under section 822.     $35,000
(2) 30 percent of taxable investment income.................      10,500
(3) 60 percent of taxable investment income in excess of                
 $3,000.....................................................      19,200
(4) Normal tax (lesser of items (2) or (3)).................      10,500
(5) Partially tax-exempt interest deducted in computing                 
 taxable investment income..................................       2,000
(6) Taxable investment income for purposes of the surtax                
 (item (1) plus item (5))...................................      37,000
(7) Surtax exemption........................................      25,000
(8) Taxable investment income subject to surtax (item (6)               
 minus item (7))............................................      12,000
(9) Surtax (22 percent of item (8)).........................       2,640
(10) Total tax liability (item (4) plus item (9))...........      13,140
                                                                        

    Example 2. N, a mutual casualty insurance company, for the taxable 
year 1963 has a gross amount received from the items described in 
section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) of $210,000. Since N's gross amount 
received exceeds $150,000 but does not exceed $500,000, N is subject to 
the tax imposed by section 821(c) on taxable investment income unless it 
elects to be subject to the tax imposed by section 821(a). Furthermore, 
since the gross amount received by N does not exceed $250,000, N is 
entitled to the special tax reduction provided by section 821(c)(2). N 
computes its taxable investment income under section 822 to be $24,000. 
In computing taxable investment income, N deducted $2,000 of partially 
tax-exempt interest under section 242. If N does not make an election to 
be taxed under section 821(a), its total tax liability for the taxable 
year 1963 is $4,452 computed as follows:

[[Page 610]]



(1) Taxable investment income as computed under section 822.     $24,000
(2) 30 percent of taxable investment income.................       7,200
(3) 60 percent of taxable investment income in excess of                
 $3,000.....................................................      12,600
(4) Normal tax (lesser of items (2) or (3)).................       7,200
(5) Partially tax-exempt interest deducted in computing                 
 taxable investment income..................................       2,000
(6) Taxable investment income for purposes of the surtax                
 (item (1) plus item (5))...................................      26,000
(7) Surtax exemption........................................      25,000
(8) Taxable investment income subject to surtax (item (6)               
 minus item (7))............................................       1,000
(9) Surtax 22 percent of item (8)...........................         220
(10) Tax liability computed without regard to special                   
 reduction (item (4) plus item (9)).........................       7,420
(11) Amount by which gross receipts exceed $150,000                     
 ($210,000 gross receipts minus $150,000)...................      60,000
(12) Percentage which item (1) bears to $100,000 ($60,000               
 over $100,000).............................................        0.60
(13) Tax as adjusted (percentage determined in item (12)                
 applied to item (10))......................................       4,452
                                                                        

If N's taxable investment income for purposes of the surtax did not 
exceed $3,000, N would file a return but would pay no tax. Had N elected 
(under section 821(d)) to be subject to tax under section 821(a), N 
would not be entitled to the special reduction afforded by section 
821(c)(2), since that provision applies only to companies taxable under 
section 821(c).

[T.D. 6681, 28 FR 11110, Oct. 17, 1963, as amended by T.D. 7100, 36 FR 
5333, Mar. 20, 1971; 36 FR 5846, Mar. 30, 1971]



Sec. 1.821-5  Special transitional underwriting loss.

    (a) In general. Section 821(f) provides a special reduction in the 
statutory underwriting income (as defined by section 823(a)(1) and 
paragraph (b)(1) of Sec. 1.823-6) of any company taxable under section 
821(a) which was taxable under section 821 for the five taxable years 
immediately preceding January 1, 1962, and which incurred an 
underwriting loss (as defined in section 821(f)(3) and paragraph (c) of 
this section) for each of such five taxable years.
    (b) Amount of reduction. In the case of a company described in 
section 821(f)(1) and paragraph (a) of this section the statutory 
underwriting income for the taxable year (determined without regard to 
this paragraph) shall be reduced by an amount equal to the amount by 
which:
    (1) The sum of the underwriting losses of such company for the five 
taxable years immediately preceding January 1, 1962, exceeds
    (2) The total amount by which the company's statutory underwriting 
income was reduced by reason of section 821(f) and this section for 
prior taxable years.
    (c) Underwriting loss defined. For purposes of computing the amount 
of the reduction available under section 821(f) and paragraph (a) of 
this section, the term underwriting loss means statutory underwriting 
loss (as defined by section 823(a)(2) and paragraph (b)(2) of 
Sec. 1.823-6) computed without any deduction under section 824(a) and 
paragraph (a) of Sec. 1.824-1 (relating to deduction to provide 
protection against losses) and without any deduction under section 
832(c)(11) (relating to dividends and similar distributions paid or 
declared to policyholders). For rules relating to the definition of 
dividends and similar distributions paid or declared to policyholders, 
see paragraph (a) of Sec. 1.832-5.
    (d) Years of applicability. Section 821(f)(4) provides that the 
special reduction of statutory underwriting income allowed by section 
821(f)(2) and paragraph (b) of this section shall apply to any taxable 
year beginning after December 31, 1962, and before January 1, 1968, for 
which the taxpayer is subject to the tax imposed by section 821(a).

[T.D. 6681, 28 FR 11112, Oct. 17, 1963]



Sec. 1.822-1   Taxable income and deductions.

    (a) In general. For taxable years beginning after December 31, 1953, 
but before January 1, 1955, and ending after August 16, 1954, the 
taxable income of a mutual insurance company subject to the tax imposed 
by section 821 is its gross investment income, namely, the gross amount 
of income during the taxable year from interest, dividends, rents, and 
gains from sales or exchanges of capital assets, less the deductions 
provided in section 822(c) for wholly tax-exempt interest, investment 
expenses, real estate expenses, depreciation, interest paid or accrued, 
capital losses to the extent provided in subchapter P (sec. 1201 and 
following), chapter 1 of the Code, and the special deductions provided 
in part VIII (section 241 and following), except section 248, subchapter 
B, chapter 1 of the Code. In addition to the limitations on deductions 
relating to real estate

[[Page 611]]

owned and occupied by a mutual insurance company subject to the tax 
imposed by section 821 provided in section 822(d)(1), the adjustment for 
amortization of premium and accrual of discount provided in section 
822(d)(2), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 822(c)(2), mutual insurance companies subject to the tax imposed 
by section 821 are subject to the limitation on deductions relating to 
wholly tax-exempt income provided in section 265. Such companies are not 
entitled to the net operating loss deduction provided in section 172.
    (b) Wholly tax-exempt interest. Interest which in the case of other 
taxpayers is excluded from gross income by section 103 but included in 
the gross investment income by section 822(b) is allowed as a deduction 
from gross investment income by section 822(c)(1).
    (c) Investment expenses. The deduction allowed by section 822(c)(2) 
for investment expenses is the same as that allowed life insurance 
companies by section 803(g)(2). See paragraph (c) of Sec. 1.803-4.
    (d) Taxes and expenses with respect to real estate. The deduction 
allowed by section 822(c)(3) for taxes and expenses with respect to real 
estate owned by the company is the same as that allowed life insurance 
companies by section 803(g)(3). See paragraph (d) of Sec. 1.803-4.
    (e) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is the same as that allowed life insurance companies by 
section 803(g)(4). See paragraph (e) of Sec. 1.803-4.
    (f) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (g) Capital losses. (1) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P but in addition thereto losses from capital 
assets sold or exchanged to provide funds to meet abnormal insurance 
losses and to provide for the payment of dividends and similar 
distributions to policyholders. Losses in the latter case may be 
deducted from ordinary income while the deduction for losses under 
subchapter P is limited to the gains. See section 1211.
    (2) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of such assets are not 
greater than the excess, if any, for the taxable year of the sum of 
dividends and similar distributions paid to policyholders, and losses 
and expenses paid over the sum of interest, dividends, rents, and net 
premiums received. If, by reason of a particular sale or exchange of a 
capital asset, gross receipts are greater than such excess, the gross 
receipts and the resulting loss should be apportioned and the excess 
included in capital losses subject to the provisions of subchapter P. 
Capital losses actually used to reduce net income in any taxable year 
may not again be used in a succeeding taxable year as an offset against 
capital gains in that year and for that purpose a special rule is set 
forth for the application of section 1212.
    (3) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
the tax imposed by section 821, in the taxable year 1954 sells capital 
assets in order to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders. The gross receipts from the sale are $60,000, resulting 
in losses of $20,000. It pays dividends to policyholders of $150,000. It 
sustains losses of $25,000, and pays expenses of $25,000. It receives 
interest of $50,000, dividends of $5,000, rents of $4,000, and net 
premiums of $66,000. The excess of the sum of dividends, losses, and 
expenses paid ($200,000) over the sum of interest, dividends, rents, and 
net premiums received ($125,000) is $75,000. As the gross receipts from 
the sale of capital assets ($60,000) do not exceed such excess 
($75,000), the losses of $20,000 are allowable as a deduction from gross 
investment income.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset sold, for the purpose therein specified, resulted in 
gross receipts of $2,000 and a loss of $500, the losses allowable as a 
deduction from gross investment income would be $19,750. The last sale 
made the gross receipts of $76,000 exceed by $1,000 the excess ($75,000) 
of

[[Page 612]]

the sum of dividends, losses, and expenses paid ($200,000) over the sum 
of interest, dividends, rents, and net premiums received ($125,000). The 
gross receipts and the resulting loss from the last sale are apportioned 
on the basis of the ratio of the excess of $1,000 to the gross receipts 
of $2,000, or 50 percent. Fifty percent of the loss of $500 is deducted 
from the total loss of $20,000. The remaining gross receipts of $1,000 
and the proportionate loss of $250 should be reported as capital losses 
under subchapter P.
    Example 3. If in example 1 the X Company had mutual insurance 
company taxable income for purposes of the surtax of $9,750 and, under 
the provisions of subchapter P, had capital losses of $18,000 and 
capital gains of $10,000, the net capital loss for the taxable year 
1954, in applying section 1212 for the purposes of section 822(c)(6), 
would be $8,000. This is determined by subtracting from total losses of 
$38,000 ($18,000 capital losses under subchapter P plus $20,000 other 
capital losses under section 822(c)(6)) the sum of capital gains of 
$10,000 and losses from the sale or exchange of capital assets sold or 
exchanged to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders of $20,000. Such losses of $20,000 are added to capital 
gains of $10,000, since they are less than taxable income for purposes 
of the surtax, computed without regard to gains or losses from sales or 
exchanges of capital assets, of $29,750 ($9,750 taxable income for 
purposes of the surtax plus $20,000 other capital losses under section 
822(c)(6) plus the portion of capital losses allowable under subchapter 
P of $10,000 minus capital gains under subchapter P of $10,000).

    (h) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code, 
relating to partially tax-exempt interest and to dividends received.



Sec. 1.822-2   Real estate owned and occupied.

    The limitation in section 822(d)(1) on the amount allowable as a 
deduction for taxes, expenses, and depreciation upon or with respect to 
any real estate owned and occupied in whole or in part by a mutual 
insurance company subject to the tax imposed by section 821 is the same 
as that provided in the case of life insurance companies by section 
803(h). See Sec. 1.803-5.



Sec. 1.822-3   Amortization of premium and accrual of discount.

    Section 822(d)(2) makes provision for the appropriate amortization 
of premium and the appropriate accrual of discount, attributable to the 
taxable year, on bonds, notes, debentures or other evidences of 
indebtedness held by a mutual insurance company subject to the tax 
imposed by section 821. Such amortization and accrual is the same as 
that provided for life insurance companies by section 803(i) and shall 
be determined in accordance with Sec. 1.803-6, except that in 
determining the premium and discount of a mutual insurance company 
subject to the tax imposed by section 821 the basis provided in section 
1012 shall be used in lieu of the acquisition value.



Sec. 1.822-4   Taxable years affected.

    Sections 1.822-1 through 1.822-3 are applicable only to taxable 
years beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, and all references to sections of part II, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, before amendments. Sections 1.822-5 through 1.822-7 are applicable 
only to taxable years beginning after December 31, 1954, but before 
January 1, 1963, and all references to sections of part II, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Tax Act for 1955 (70 Stat. 36). 
Sections 1.822-8 through 1.822-12 are applicable only to taxable years 
beginning after December 31, 1962, and all references to sections of 
parts II and III, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954 as amended by section 8 of the Revenue Act 
of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11113, Oct. 17, 1963]



Sec. 1.822-5   Mutual insurance company taxable income.

    (a) Mutual insurance company taxable income defined. Section 822(a) 
defines the term ``mutual insurance company taxable income'' for 
purposes of part II, subchapter L, chapter 1 of the Code. Mutual 
insurance company taxable income means gross investment income

[[Page 613]]

(as defined in section 822(b) and paragraph (b) of this section), less 
the deductions provided in section 822(c) and paragraph (c) of this 
section for wholly tax-exempt interest, investment expenses, real estate 
expenses, depreciation, interest paid or accrued, capital losses, 
special deductions, trade or business (other than in insurance business) 
expenses, and depletion. However, such expenses are deductible only to 
the extent that they relate to investment income and the deduction of 
such expenses is not disallowed by any other provision of subtitle A of 
the Code. For example, investment expenses are not allowable unless they 
are ordinary and necessary expenses within the meaning of section 162. 
In addition to the limitations on deductions relating to real estate 
owned and occupied by a mutual insurance company subject to the tax 
imposed by section 821 provided in section 822(d)(1), the adjustment for 
amortization of premium and accrual of discount provided in section 
822(d)(2), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 822(c)(2), mutual insurance companies subject to the tax imposed 
by section 821 are subject to the limitation on deductions relating to 
wholly tax-exempt income provided in section 265. Such companies are not 
entitled to the net operating loss deduction provided in section 172, 
and a deduction shall not be permitted with respect to the same item 
more than once.
    (b) Gross investment income defined. For purposes of part II, 
subchapter L, chapter 1 of the Code, section 822(b) defines the term 
``gross investment income'' of a mutual insurance company subject to the 
tax imposed by section 821 as the sum of the following:
    (1) The gross amount of income during the taxable year from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 822(d)(2) and Sec. 1.822-7;
    (ii) Dividends, as described in Sec. 1.61-9;
    (iii) Rents and royalties, as described in Sec. 1.61-8;
    (iv) The entering into of any lease, mortgage or other instrument or 
agreement from which the company may derive interest, rents, or 
royalties;
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph;
    (vi) Gains from sales or exchanges of capital assets to the extent 
provided in subchapter P (section 1201 and following, relating to 
capital gains and losses), chapter 1 of the Code.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by a mutual insurance company subject to 
the tax imposed by section 821, or by a partnership of which the 
insurance company is a partner.

For example, gross investment income includes amounts received as 
commitment fees, or as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage. In computing the gross 
income from any trade or business (other than an insurance business) 
carried on by the insurance company, or by a partnership of which the 
insurance company is a partner, any item described in section 822(b)(1) 
and paragraph (b)(1) of this section shall not be considered as gross 
income arising from the conduct of such trade or business, but shall be 
taken into account under section 822(b)(1) and paragraph (b)(1) of this 
section.
    (c) Deductions from gross investment income--(1) Wholly tax-exempt 
interest. Interest which in the case of other taxpayers is excluded from 
gross income by section 103 but included in the gross investment income 
by section 822(b) is allowed as a deduction from gross investment income 
by section 822(c)(1).
    (2) Investment expenses. (i) The deduction for investment expenses 
under section 822(c)(2) includes only those expenses of the taxable year 
which are fairly chargeable against gross investment income. For 
example, investment expenses include salaries and expenses paid 
exclusively for work in looking after investments, and amounts expended 
for printing, stationery, postage, and stenographic work incident to the 
collection of interest. An itemized

[[Page 614]]

schedule of such expenses shall be attached to the return.
    (ii) Any assignment of general expenses to the investment department 
of a mutual insurance company subject to the tax imposed by section 821 
subjects the entire deduction for investment expenses to the limitation 
provided in section 822(c)(2) and subdivision (iii) of this 
subparagraph. As used in section 822(c)(2), the term ``general 
expenses'' means any expense paid or incurred for the benefit of more 
than one department of the company rather than for the benefit of a 
particular department thereof. For example, if an expense, such as a 
salary, is attributable to more than one department, including the 
investment department, such expense may be properly allocated among 
these departments. If such expense is allocated, the amount properly 
allocable to the investment department shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 822(c)(2) and subdivision 
(iii) of this subparagraph. However, a company subject to the tax 
imposed by section 821 shall not deduct under section 822(c)(2) its real 
estate taxes, depreciation, or other expenses with respect to any 
portion of the real estate which it owns, irrespective of whether such 
items are properly allocable to its investment department. For the rules 
relating to the deductibility of these items, see section 822(c) (3) and 
(4) and subparagraphs (3) and (4) of this paragraph. If general expenses 
are in part assigned to or included in investment expenses, the maximum 
allowance (as determined under section 822(c)(2) shall not be granted 
unless it is shown to the satisfaction of the district director that 
such allowance is justified by a reasonable assignment of actual 
expenses. The accounting procedure employed is not conclusive as to 
whether any assignment has in fact been made. Investment expenses do not 
include Federal income and excess profits taxes, if any.
    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 822(c)(2) shall 
not exceed the sum of:
    (a) One-fourth of 1 percent of the mean of the book value of the 
invested assets held at the beginning and end of the taxable year, plus.
    (b) One-fourth of the amount by which mutual insurance company 
taxable income (computed without any deduction for investment expenses, 
tax-free interest, partially tax-exempt interest, or dividends received) 
exceeds 33/4 percent of the book value of the mean of the invested 
assets held at the beginning and end of the taxable year.

For purposes of section 822(c)(2) and this paragraph, the term 
``invested assets'' means only those assets which are owned and used, 
and to the extent used, for the purpose of producing the income 
specified in section 822(b). See paragraph (b) of this section. The term 
does not include real estate owned and occupied, and to the extent owned 
and occupied, by the company.
    (3) Real estate expenses and taxes. The deduction for real estate 
expenses and taxes under section 822(c)(3) includes taxes (as defined in 
section 164) and other expenses for the taxable year exclusively on or 
with respect to real estate owned by the company. For example, no 
deduction shall be allowed under section 822(c)(3) for amounts allowed 
as a deduction under section 164(e) (relating to taxes of shareholders 
paid by a corporation). No deduction shall be allowed under section 
822(c)(3) for any amount paid out for new buildings, or for permanent 
improvements or betterments made to increase the value of any property. 
An itemized schedule of such taxes and expenses shall be attached to the 
return. See Sec. 1.822-6 for limitation of such deduction.
    (4) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is, except as provided in section 822(d)(1) and Sec. 1.822-
6, identical to that allowed other corporations by section 167. Such 
amount allowed as a deduction from gross investment income in 
determining mutual insurance company taxable income is limited to 
depreciation sustained on the property used, and to the extent used, for 
the purpose of producing the income specified in section 822(b).

[[Page 615]]

    (5) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (6) Capital losses. (i) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P, chapter 1 of the Code but in addition thereto 
losses from capital assets sold or exchanged to provide funds to meet 
abnormal insurance losses and to provide for the payment of dividends 
and similar distributions to policyholders. Losses in the latter case 
may be deducted from ordinary income while the deduction for losses 
under subchapter P is limited to the gains. See section 1211.
    (ii) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of such assets are not 
greater than the excess, if any, for the taxable year of the sum of 
dividends and similar distributions paid to policyholders, and losses 
and expenses paid over the sum of the items described in section 822(b) 
(other than paragraph (1)(D) thereof) and net premiums received. If, by 
reason of a particular sale or exchange of a capital asset, gross 
receipts are greater than such excess, the gross receipts and the 
resulting loss should be apportioned and the excess included in capital 
losses subject to the provisions of subchapter P. Capital losses 
actually used to reduce net income in any taxable year may not again be 
used in a succeeding taxable year as an offset against capital gains in 
that year and for that purpose a special rule is set forth for the 
application of section 1212.
    (iii) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
the tax imposed by section 821, in the taxable year 1958 sells capital 
assets in order to obtain funds to meet abnormal insurance losses and to 
provide for the payment of dividends and similar distributions to 
policyholders. The gross receipts from the sale are $60,000, resulting 
in losses of $20,000. It pays dividends to policyholders of $150,000. It 
sustains losses of $25,000, and pays expenses of $25,000. It receives 
interest of $50,000, dividends of $5,000, royalties of $4,000, and net 
premiums of $66,000. The excess of the sum of dividends, losses, and 
expenses paid ($200,000) over the sum of the items described in section 
822(b) (other than paragraph (1)(D) thereof) and net premiums received 
($125,000) is $75,000. As the gross receipts from the sale of capital 
assets ($60,000) do not exceed such excess ($75,000), the losses of 
$20,000 are allowable as a deduction from gross investment income.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset sold, for the purpose therein specified, resulted in 
gross receipts of $2,000 and a loss of $500, the losses allowable as a 
deduction from gross investment income would be $19,750. The last sale 
made the gross receipts of $76,000 exceed by $1,000 the excess ($75,000) 
of the sum of dividends, losses, and expenses paid ($200,000) over the 
sum of the items described in section 822(b) (other than paragraph 
(1)(D) thereof) and net premiums received ($125,000). The gross receipts 
and the resulting loss from the last sale are apportioned on the basis 
of the ratio of the excess of $1,000 to the gross receipts of $2,000, or 
50 percent. Fifty percent of the loss of $500 is deducted from the total 
loss of $20,000. The remaining gross receipts of $1,000 and the 
proportionate loss of $250 should be reported as capital losses under 
subchapter P.
    Example 3. If in example 1 the X Company had mutual insurance 
company taxable income for purposes of the surtax of $9,750 and, under 
the provisions of subchapter P, chapter 1 of the Code, had capital 
losses of $18,000 and capital gains of $10,000, the net capital loss for 
the taxable year 1958, in applying section 1212 for the purposes of 
section 822(c)(6), would be $8,000. This is determined by subtracting 
from total losses of $38,000 ($18,000 capital losses under subchapter P 
plus $20,000 other capital losses under section 822(c)(6)) the sum of 
capital gains of $10,000 and losses from the sale or exchange of capital 
assets sold or exchanged to obtain funds to meet abnormal insurance 
losses and to provide for the payment of dividends and similar 
distributions to policyholders of $20,000. Such losses of $20,000 are 
added to capital gains of $10,000, since they are less than taxable 
income for purposes of the surtax, computed without regard to gains or 
losses from sales or exchanges of capital assets, of $29,750 ($9,750 
taxable income for purposes of the surtax plus $20,000 other capital 
losses under section 822(c)(6) plus the portion of capital losses 
allowable under subchapter P of $10,000 minus capital gains under 
subchapter P of $10,000).

    (7) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except

[[Page 616]]

section 248, subchapter B, chapter 1 of the Code, relating to partially 
tax-exempt interest and to dividends received.
    (8) Trade or business deductions. (i) Under section 822(c)(8), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are attributable to any trade or business (other than an 
insurance business) carried on by the insurance company, or by a 
partnership of which the company is a partner are, subject to the 
limitations in subdivision (ii) of this subparagraph, allowable as 
deductions from gross investment income in computing mutual insurance 
company taxable income. Such deductions are allowable, however, only to 
the extent that they relate to income which is included in the company's 
gross investment income by reason of section 822(b) (2). Thus, a 
deduction shall not be allowed under section 822(c)(8) with respect to 
any item described in section 822(b)(1). The allowable deductions may 
exceed the gross income from such business.
    (ii) In computing the deductions under section 822(c)(8):
    (a) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if the 
company operates a radio station primarily to advertise its own 
insurance services, a portion of the expenses of the radio station shall 
not be allowed as a deduction. The portion disallowed shall be an amount 
which bears the same ratio to the total expenses of the station as the 
value of advertising furnished to the insurance company bears to the 
total value of services rendered by the station.
    (b) The deduction for net operating losses provided in section 172 
shall not be allowed.
    (9) Depletion. The deduction allowed by section 822(c)(9) for 
depletion is the same as that allowed life insurance companies under 
section 804(c)(4). See paragraph (b)(5) of Sec. 1.804-4.

[T.D. 6610, 27 FR 8720, Aug. 31, 1962, as amended by T.D. 6631, 28 FR 
219, Jan. 9, 1963]



Sec. 1.822-6   Real estate owned and occupied.

    Section 822(d)(1) provides that the amount allowable as a deduction 
for taxes, expenses, and depreciation on or with respect to any real 
estate owned and occupied in whole or in part by a mutual insurance 
company subject to the tax imposed by section 821 shall be limited to an 
amount which bears the same ratio to such deduction (computed without 
regard to this limitation) as the rental value of the space not so 
occupied bears to the rental value of the entire property. For example, 
if the rental value of the space not occupied by the company is equal to 
one-half of the rental value of the entire property, the deduction for 
taxes, expenses, and depreciation is one-half of the taxes, expenses, 
and depreciation on account of the entire property. Where a deduction is 
claimed as provided in this section, the parts of the property occupied 
and the parts not occupied by the company, together with the respective 
rental values thereof, must be shown in a statement accompanying the 
return.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.822-7   Amortization of premium and accrual of discount.

    Section 822(d)(2) makes provision for the appropriate amortization 
of premium and the appropriate accrual of discount, attributable to the 
taxable year, on bonds, notes, debentures, or other evidences of 
indebtedness held by a mutual insurance company subject to the tax 
imposed by section 821. Such amortization and accrual is the same as 
that provided for life insurance companies by section 818(b)(1), as 
amended by the Life Insurance Company Income Tax Act of 1959 (73 Stat. 
133), and shall be determined in accordance with paragraphs (a) and (b) 
of Sec. 1.818-3, except in the case of a mutual insurance company 
subject to the tax imposed by section 821, paragraph (b) of Sec. 1.818-3 
shall apply without regard to the date of acquisition and the basis 
provided in section 1012 shall be used in lieu of the acquisition value.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.822-8  Determination of taxable investment income.

    (a) In general--(1) Taxable investment income defined. Section 
822(a)(1) defines the term ``taxable investment income''

[[Page 617]]

for purposes of part II, subchapter L, chapter 1 of the Code as the 
gross investment income (as defined in section 822(b) and paragraph (b) 
of this section), less the deductions provided in section 822(c) and 
paragraph (c) of this section for wholly tax-exempt interest, investment 
expenses, real estate expenses, depreciation, interest paid or accrued, 
capital losses, special deductions, trade or business (other than an 
insurance business) expenses, and depletion. However, such expenses are 
deductible only to the extent that they relate to investment income and 
the deduction of such expenses is not disallowed by any other provision 
of subtitle A of the Code.

For example, investment expenses are not allowable unless they are 
ordinary and necessary expenses within the meaning of section 162. In 
addition to the limitations on deductions relating to real estate owned 
and occupied by a mutual insurance company subject to the tax imposed by 
section 821 provided in section 822(d)(1), the adjustment for 
amortization of premium and accrual of discount provided in section 
822(d)(2), and the limitation on the deduction for investment expenses 
where general expenses are allocated to investment income provided in 
section 822(c)(2), mutual insurance companies subject to the tax imposed 
by section 821 (a) or (c) are subject to the limitation on deductions 
relating to wholly tax-exempt income provided in section 265. Such 
companies are not entitled to the net operating loss deduction provided 
in section 172. See, however, section 825 and paragraph (a) of 
Sec. 1.825-1 for unused loss deduction allowed companies taxable under 
section 821(a). A deduction shall not be permitted with respect to the 
same item more than once.
    (2) Investment loss defined. The term ``investment loss'' is defined 
by section 822(a)(2) as the amount by which the deductions allowable 
under section 822(c) and paragraph (c) of this section exceed the gross 
investment income (as defined in section 822(b) and paragraph (b) of 
this section).
    (b) Gross investment income defined. For purposes of part II, 
subchapter L, chapter 1 of the Code, section 822(b) defines the term 
``gross investment income'' of a mutual insurance company subject to the 
tax imposed by section 821 (a) or (c) as the sum of the following:
    (1) The gross amount of income during the taxable year from:
    (i) Interest (including tax-exempt interest and partially tax-exempt 
interest), as described in Sec. 1.61-7. Interest shall be adjusted for 
amortization of premium and accrual of discount in accordance with the 
rules prescribed in section 822(d)(2) and Sec. 1.822-10;
    (ii) Dividends, as described in Sec. 1.61-9;
    (iii) Rents and royalties, as described in Sec. 1.61-8;
    (iv) The entering into of any lease, mortgage or other instrument or 
agreement from which the company may derive interest, rents, or 
royalties;
    (v) The alteration or termination of any instrument or agreement 
described in subdivision (iv) of this subparagraph;
    (vi) Gains from sales or exchanges of capital assets to the extent 
provided in subchapter P (section 1201 and following, relating to 
capital gains and losses) chapter 1 of the Code.
    (2) The gross income from any trade or business (other than an 
insurance business) carried on by a mutual insurance company subject to 
the tax imposed by section 821 (a) or (c), or by a partnership of which 
the insurance company is a partner.

For example, gross investment income includes amounts received as 
commitment fees, or as a bonus for the entering into of a lease, or as a 
penalty for the early payment of a mortgage. In computing the gross 
income from any trade or business (other than an insurance business) 
carried on by the insurance company, or by a partnership of which the 
insurance company is a partner, any item described in section 822(b)(1) 
and paragraph (b)(1) of this section shall not be considered as gross 
income arising from the conduct of such trade or business, but shall be 
taken into account under section 822(b)(1) and paragraph (b)(1) of this 
section.
    (c) Deductions from gross investment income--(1) Wholly tax-exempt 
interest. Interest which in the case of other taxpayers is excluded from 
gross income by section 103 but included in the gross

[[Page 618]]

investment income by section 822(b) is allowed as a deduction from gross 
investment income by section 822(c)(1).
    (2) Investment expenses. (i) The deduction for investment expenses 
under section 822(c)(2) includes only those expenses of the taxable year 
which are fairly chargeable against gross investment income. For 
example, investment expenses include salaries and expenses paid 
exclusively for work in looking after investments, and amounts expended 
for printing, stationery, postage, and stenographic work incident to the 
collection of interest. An itemized schedule of such expenses shall be 
attached to the return.
    (ii) Any assignment of general expenses to the investment department 
of a mutual insurance company subject to the tax imposed by section 821 
(a) or (c) subjects the entire deduction for investment expenses to the 
limitation provided in section 822(c)(2) and subdivision (iii) of this 
subparagraph. As used in section 822(c)(2), the term ``general 
expenses'' means any expense paid or incurred for the benefit of more 
than one department of the company rather than for the benefit of a 
particular department thereof. For example, if an expense, such as a 
salary, is attributable to more than one department, including the 
investment department, such expense may be properly allocated among 
these departments. If such expense is allocated, the amount properly 
allocable to the investment department shall be deductible as general 
expenses assigned to or included in investment expenses and as such 
shall be subject to the limitation of section 822(c)(2) and subdivision 
(iii) of this subparagraph. However, a company subject to the tax 
imposed by section 821 (a) or (c) shall not deduct under section 
822(c)(2) its real estate taxes, depreciation, or other expenses with 
respect to any portion of the real estate which it owns, irrespective of 
whether such items are properly allocable to its investment department. 
For the rules relating to the deductibility of these items, see section 
822(c) (3) and (4) and subparagraphs (3) and (4) of this paragraph. If 
general expenses are in part assigned to or included in investment 
expenses, the maximum allowance (as determined under section 822(c)(2)) 
shall not be granted unless it is shown to the satisfaction of the 
district director that such allowance is justified by a reasonable 
assignment of actual expenses. The accounting procedure employed is not 
conclusive as to whether any assignment has in fact been made. 
Investment expenses do not include Federal income and excess profits 
taxes, if any.
    (iii) If any general expenses are in part assigned to or included in 
investment expenses, the total deduction under section 822(c)(2) shall 
not exceed the sum of:
    (a) One-fourth of 1 percent of the mean of the book value of the 
invested assets held at the beginning and end of the taxable year, plus
    (b) One-fourth of the amount by which taxable investment income 
(computed without any deduction for investment expenses, tax-free 
interest, partially tax-exempt interest, or dividends received) exceeds 
33/4 percent of the book value of the mean of the invested assets held 
at the beginning and end of the taxable year.

For purposes of section 822(c)(2) and this paragraph, the term 
``invested assets'' means only those assets which are owned and used, 
and to the extent used, for the purpose of producing the income 
specified in section 822(b). See paragraph (b) of this section. The term 
does not include real estate owned and occupied, and to the extent owned 
and occupied, by the company.
    (3) Real estate expenses and taxes. The deduction for real estate 
expenses and taxes under section 822(c)(3) includes taxes (as defined in 
section 164) and other expenses for the taxable year exclusively on or 
with respect to real estate owned by the company. For example, no 
deduction shall be allowed under section 822(c)(3) for amounts allowed 
as a deduction under section 164(e) (relating to taxes of shareholders 
paid by a corporation). No deduction shall be allowed under section 
822(c)(3) for any amount paid out for new buildings, or for permanent 
improvements or betterments made to increase the value of any property. 
An itemized schedule of such taxes and expenses shall be attached to the 
return. See Sec. 1.822-9 for limitation of such deduction.

[[Page 619]]

    (4) Depreciation. The deduction allowed by section 822(c)(4) for 
depreciation is, except as provided in section 822(d)(1) and Sec. 1.822-
9, identical to that allowed other corporations by section 167. Such 
amount allowed as a deduction from gross investment income in 
determining taxable investment income is limited to depreciation 
sustained on the property used, and to the extent used, for the purpose 
of producing the income specified in section 822(b).
    (5) Interest paid or accrued. The deduction allowed by section 
822(c)(5) for interest on indebtedness is the same as that allowed other 
corporations by section 163. See Sec. 1.163-1.
    (6) Capital losses. (i) The deduction for capital losses under 
section 822(c)(6) includes not only capital losses to the extent 
provided in subchapter P, chapter 1 of the Code but in addition thereto 
losses from capital assets sold or exchanged to provide funds to meet 
abnormal insurance losses and to provide for the payment of dividends 
and similar distributions to policyholders. Losses in the latter case 
may be deducted from ordinary income while the deduction for losses 
under subchapter P is limited to the gains. See section 1211.
    (ii) Capital assets are considered as sold or exchanged to provide 
for the funds or payments specified in section 822(c)(6), to the extent 
that the gross receipts from the sale or exchange of such assets are not 
greater than the excess, if any, for the taxable year of the sum of 
dividends and similar distributions paid to policyholders, and losses 
and expenses paid over the sum of the items described in section 822(b) 
(other than paragraph (1)(D) thereof) and net premiums received. If, by 
reason of a particular sale or exchange of a capital asset, gross 
receipts are greater than such excess, the gross receipts and the 
resulting loss should be apportioned and the excess included in capital 
losses subject to the provisions of subchapter P. Capital losses 
actually used to reduce net income in any taxable year may not again be 
used in a succeeding taxable year as an offset against capital gains in 
that year and for that purpose a special rule is set forth for the 
application of section 1212.
    (iii) The application of section 822(c)(6) may be illustrated by the 
following examples:

    Example 1. The X Company, a mutual fire insurance company subject to 
tax under section 821, in the taxable year 1963 sells capital assets in 
order to obtain funds to meet abnormal insurance losses and to provide 
for the payment of dividends and similar distributions to policyholders. 
The gross receipts from the sale are $60,000, resulting in losses of 
$20,000. It pays dividends to policyholders of $150,000. It sustains 
losses of $25,000, and pays expenses of $25,000. It receives interest of 
$50,000, dividends of $5,000, royalties of $4,000, and net premiums of 
$66,000. The excess of the sum of dividends, losses, and expenses paid 
($200,000) over the sum of the items described in section 822(b) (other 
than paragraph (1)(D) thereof) and net premiums received ($125,000) is 
$75,000. Since the gross receipts from the sale of capital assets 
($60,000) do not exceed such excess ($75,000), the losses of $20,000 are 
allowable as a deduction from gross investment income in computing 
taxable investment income under section 822.
    Example 2. If in example 1 the gross receipts were $76,000 and the 
last capital asset sold, for the purpose therein specified, resulted in 
gross receipts of $2,000 and a loss of $500, the losses allowable as a 
deduction from gross investment income would be $19,750. The last sale 
made the gross receipts of $76,000 exceed by $1,000 the excess ($75,000) 
of the sum of dividends, losses, and expenses paid ($200,000) over the 
sum of the items described in section 822(b) (other than paragraph 
(1)(D) thereof) and net premiums received ($125,000). The gross receipts 
and the resulting loss from the last sale are apportioned on the basis 
of the ratio of the excess of $1,000 to the gross receipts of $2,000, or 
50 percent. Fifty percent of the loss of $500 is deducted from the total 
loss of $20,000. The remaining gross receipts of $1,000 and the 
proportionate loss of $250 should be reported as capital losses under 
subchapter P.
    Example 3. If in example 1 the X Company had taxable investment 
income for purposes of the surtax of $9,750 and, under the provisions of 
subchapter P, chapter 1 of the Code, had capital losses of $18,000 and 
capital gains of $10,000, the net capital loss for the taxable year 
1963, in applying section 1212 for the purposes of section 822(c)(6), 
would be $8,000. This is determined by subtracting from total losses of 
$38,000 ($18,000 capital losses under subchapter P plus $20,000 other 
capital losses under section 822(c)(6)) the sum of capital gains of 
$10,000 and losses from the sale or exchange of capital assets sold or 
exchanged to obtain funds to meet abnormal insurance

[[Page 620]]

losses and to provide for the payment of dividends and similar 
distributions to policyholders of $20,000. Such losses of $20,000 are 
added to capital gains of $10,000, since they are less than taxable 
investment income for purposes of the surtax, computed without regard to 
gains or losses from sales or exchanges of capital assets, of $29,750 
($9,750 taxable investment income for purposes of the surtax plus 
$20,000 other capital losses under section 822(c)(6) plus the portion of 
capital losses allowable under subchapter P of $10,000 minus capital 
gains under subchapter P of $10,000).

    (7) Special deductions. Section 822(c)(7) allows a mutual insurance 
company the special deductions provided by part VIII (section 241 and 
following), except section 248, subchapter B, chapter 1 of the Code, 
relating to partially tax-exempt interest and to dividends received. In 
applying section 246(b) (relating to limitation on aggregate amount of 
deductions for dividends received) for purposes of this subparagraph, 
the reference in such section to ``taxable income'' shall be treated as 
a reference to ``taxable investment income''.
    (8) Trade or business deductions. (i) Under section 822(c)(8), the 
deductions allowed by subtitle A of the Code (without regard to this 
part) which are attributable to any trade or business (other than an 
insurance business) carried on by the insurance company, or by a 
partnership of which the company is a partner are, subject to the 
limitations in subdivision (ii) of this subparagraph, allowable as 
deductions from gross investment income in computing taxable investment 
income. Such deductions are allowable, however, only to the extent that 
they relate to income which is included in the company's gross 
investment income by reason of section 822(b)(2). Thus, a deduction 
shall not be allowed under section 822(c)(8) with respect to any item 
described in section 822(b)(1). The allowable deductions may exceed the 
gross income from such business.
    (ii) In computing the deductions under section 822(c)(8):
    (a) Any item, to the extent attributable to the carrying on of the 
insurance business, shall not be taken into account. For example, if the 
company operates a radio station primarily to advertise its own 
insurance services, a portion of the expenses of the radio station shall 
not be allowed as a deduction. The portion disallowed shall be an amount 
which bears the same ratio to the total expenses of the station as the 
value of advertising furnished to the insurance company bears to the 
total value of services rendered by the station.
    (b) The deduction for net operating losses provided in section 172 
shall not be allowed.
    (9) Depletion. The deduction allowed by section 822(c)(9) for 
depletion is the same as that allowed life insurance companies under 
section 804(c)(4). See paragraph (b)(5) of Sec. 1.804-4.

[T.D. 6681, 28 FR 11113, Oct. 17, 1963]



Sec. 1.822-9   Real estate owned and occupied.

    Section 822(d)(1) provides that the amount allowable as a deduction 
for taxes, expenses, and depreciation on or with respect to any real 
estate owned and occupied in whole or in part by a mutual insurance 
company subject to the tax imposed by section 821 (a) or (c) shall be 
limited to an amount which bears the same ratio to such deduction 
(computed without regard to this limitation) as the rental value of the 
space not so occupied bears to the rental value of the entire property. 
For example, if the rental value of the space not occupied by the 
company is equal to one-half of the rental value of the entire property, 
the deduction for taxes, expenses, and depreciation is one-half of the 
taxes, expenses, and depreciation on account of the entire property. 
Where a deduction is claimed as provided in this section, the parts of 
the property occupied and the parts not occupied by the company, 
together with the respective rental values thereof, must be shown in a 
statement accompanying the return.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-10   Amortization of premium and accrual of discount.

    (a) In general. In computing taxable investment income for the 
taxable year, the gross amount of income from interest, the deduction 
under section 822(c)(1) for wholly tax-exempt interest, and the 
deduction under section

[[Page 621]]

242 for partially tax-exempt interest, are, under the provisions of 
section 822(d)(2), each to be decreased by the appropriate amortization 
of premium and increased by the appropriate accrual of discount 
attributable to the taxable year on bonds, notes, debentures, or other 
evidences of indebtedness held by a mutual insurance company subject to 
the tax imposed by section 821 (a) or (c). However, only the accrual of 
discount relating to issue discount will increase the deduction for 
wholly tax-exempt interest. See section 103. Such amortization and 
accrual is the same as that provided for life insurance companies by 
section 818(b)(1), as amended by the Life Insurance Company Income Tax 
Act of 1959 (73 Stat. 133), and shall be determined in accordance with 
paragraphs (a) and (b) of Sec. 1.818-3, except as provided by paragraph 
(b) of this section.
    (b) Modifications. (1) Paragraph (b) of Sec. 1.818-3 shall apply to 
mutual casualty insurance companies subject to the tax imposed by 
section 821 (a) or (c) without regard to the date of acquisition of the 
particular securities to which the amortization of premium or accrual of 
discount is attributable.
    (2) In computing the amount of premium or discount for purposes of 
section 822(d)(2) with respect to securities held by a company taxable 
under section 821, the basis provided by section 1012 shall be used in 
lieu of the acquisition value provided by paragraph (b) of Sec. 1.818-3. 
In the case of a company subject to the tax imposed by section 821(c), 
adjustments to basis to reflect the accrual of discount and the 
amortization of premium shall be made in the manner provided by 
paragraphs (a) and (b) of Sec. 1.818-3. However, for purposes of 
determining statutory underwriting income or loss for the taxable year 
under section 823, a company subject to the tax imposed by section 
821(a) is not required to accrue discount or to amortize premium in 
computing its income under section 832 as if it were subject to the tax 
imposed by section 831. Thus, the accrual of discount and amortization 
of premium required in the computation of taxable investment income by a 
company subject to the tax imposed by section 821(a) neither increases 
nor decreases the mutual insurance company taxable income of such a 
company and, except to the extent such a company actually accrues 
discount or amortizes premium for purposes of making the section 832 
computation, no adjustment shall be made to the basis of obligations 
held by it to reflect accrual of discount or amortization of premium.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-11   Net premiums.

    The term ``net premiums'', defined in section 822(f)(1), includes 
deposits and assessments, but excludes amounts returned to policyholders 
which are treated as dividends under section 822(f)(2). Net premiums are 
used in sections 822(c)(6) and 832(c)(5) in determining the limitation 
on certain capital losses and in the application of section 1212.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.822-12   Dividends to policyholders.

    (a) Dividends to policyholders are used in determining the 
``underwriting loss'' for purposes of the special transitional 
underwriting loss deduction provided by section 821(f), and the 
limitation on capital losses under section 822(c)(6); in computing 
statutory underwriting income or loss under section 823, and the 
subtractions from the protection against loss account under section 
824(d). The term ``dividends to policyholders'' is defined in section 
822(f)(2) as dividends and similar distributions paid or declared to 
policyholders. It includes amounts returned to policyholders where the 
amount is not fixed in the insurance contract but depends upon the 
experience of the company or the discretion of the management. Such 
amounts are not to be treated as return premiums under section 
822(f)(1). Savings credited to the individual accounts of the 
subscribers of a reciprocal underwriter or interinsurer under section 
823(b)(2) are not dividends paid or declared within the meaning of this 
paragraph. However, distributions in respect of such credits shall be 
considered as dividends paid. See section 823(b)(2) and paragraph (c)(2) 
of Sec. 1.823-6. The term ``paid or declared'' is to be construed 
according to the method of accounting regularly

[[Page 622]]

employed in keeping the books of the insurance company, and such method 
shall be consistently followed with respect to all deductions (including 
dividends and similar distributions to policyholders) and all items of 
income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed by 
adding the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year to dividends and similar 
distributions paid during the taxable year and deducting dividends and 
similar distributions declared but unpaid at the beginning of the 
taxable year. If an insurance company using the accrual method does not 
compute the deduction for dividends and similar distributions declared 
to policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as to when dividends are considered paid, see the 
regulations under section 561.

[T.D. 6681, 28 FR 11115, Oct. 17, 1963]



Sec. 1.823-1   Net premiums.

    Net premiums are one of the items used, together with interest, 
dividends, and rents, less dividends to policyholders and wholly tax-
exempt interest, in determining tax liability under section 821(a)(2). 
They are also used in section 822(c)(6) in determining the limitation on 
certain capital losses and in the application of section 1212. The term 
``net premiums'' is defined in section 823(1) and includes deposits and 
assessments, but excludes amounts returned to policyholders which are 
treated as dividends under section 823(2).



Sec. 1.823-2   Dividends to policyholders.

    (a) Dividends to policyholders is one of the deductions used, 
together with wholly tax-exempt interest, in determining tax liability 
under section 821(a)(2). They are also used in section 822(c)(6) in 
determining the limitation on certain capital losses and in the 
application of section 1212. The term ``dividends to policyholders'' is 
defined in section 823(2) as dividends and similar distributions paid or 
declared to policyholders. It includes amounts returned to policyholders 
where the amount is not fixed in the insurance contract but depends upon 
the experience of the company or the discretion of the management. Such 
amounts are not to be treated as return premiums under section 823(1). 
Similar distributions include such payments as the so-called unabsorbed 
premium deposits returned to policyholders by factory mutual fire 
insurance companies. The term ``paid or declared'' is to be construed 
according to the method of accounting regularly employed in keeping the 
books of the insurance company, and such method shall be consistently 
followed with respect to all deductions (including dividends and similar 
distributions to policyholders) and all items of income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed as 
follows:

    To dividends and similar distributions paid during the taxable year 
add the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year and deduct dividends and similar 
distributions declared but unpaid at the beginning of the taxable year.

If an insurance company using the accrual method does not compute the 
deduction for dividends and similar distributions declared to 
policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as

[[Page 623]]

to when dividends are considered paid, see the regulations under section 
561.



Sec. 1.823-3   Taxable years affected.

    Sections 1.823-1 and 1.823-2 are applicable only to taxable years 
beginning after December 31, 1953, but before January 1, 1955, and 
ending after August 16, 1954, and all references to sections of part II, 
subchapter L, chapter 1 of the Code are to the Internal Revenue Code of 
1954, before amendments. Sections 1.823-4 and 1.823-5 are applicable 
only to taxable years beginning after December 31, 1954, but before 
January 1, 1963, and all references to sections of part II, subchapter 
L, chapter 1 of the Code are to the Internal Revenue Code of 1954, as 
amended by the Life Insurance Company Tax Act for 1955 (70 Stat. 36). 
Sections 1.823-6 through 1.823-8 are applicable only to taxable years 
beginning after December 31, 1962, and all references to sections of 
parts II and III, subchapter L, chapter 1 of the Code are to the 
Internal Revenue Code of 1954 as amended by section 8 of the Revenue Act 
of 1962 (76 Stat. 989).

[T.D. 6681, 28 FR 11116, Oct. 17, 1963]



Sec. 1.823-4   Net premiums.

    Net premiums are one of the items used, together with the gross 
amount of income during the taxable year from the items described in 
section 822(b) (other than paragraph (1)(D) thereof), less dividends to 
policyholders and wholly tax-exempt interest, in determining tax 
liability under section 821(a)(2). They are also used in section 
822(c)(6) in determining the limitation on certain capital losses and in 
the application of section 1212. The term ``net premiums'' is defined in 
section 823(1) and includes deposits and assessments, but excludes 
amounts returned to policyholders which are treated as dividends under 
section 823(2).

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]



Sec. 1.823-5   Dividends to policyholders.

    (a) Dividends to policyholders is one of the deductions used, 
together with wholly tax-exempt interest, in determining tax liability 
under section 821(a)(2). They are also used in section 822(c)(6) in 
determining the limitation on certain capital losses and in the 
application of section 1212. The term ``dividends to policyholders'' is 
defined in section 823(2) as dividends and similar distributions paid or 
declared to policyholders. It includes amounts returned to policyholders 
where the amount is not fixed in the insurance contract but depends upon 
the experience of the company or the discretion of the management. Such 
amounts are not to be treated as return premiums under section 823(1). 
Similar distributions include such payments as the so-called unabsorbed 
premium deposits returned to policyholders by factory mutual fire 
insurance companies. The term ``paid or declared'' is to be construed 
according to the method of accounting regularly employed in keeping the 
books of the insurance company, and such method shall be consistently 
followed with respect to all deductions (including dividends and similar 
distributions to policyholders) and all items of income.
    (b) If the method of accounting so employed is the cash receipts and 
disbursements method, the deduction is limited to the dividends and 
similar distributions actually paid to policyholders in the taxable 
year. If, on the other hand, the method of accounting so employed is the 
accrual method, the deduction, or a reasonably accurate estimate 
thereof, for dividends and similar distributions declared to 
policyholders for any taxable year will, in general, be computed as 
follows: To dividends and similar distributions paid during the taxable 
year add the amount of dividends and similar distributions declared but 
unpaid at the end of the taxable year and deduct dividends and similar 
distributions declared but unpaid at the beginning of the taxable year. 
If an insurance company using the accrual method does not compute the 
deduction for dividends and similar distributions declared to 
policyholders in the manner stated, it must submit with its return a 
full and complete explanation of the manner in which the deduction is 
computed. For the rule as to when dividends are considered paid, see the 
regulations under section 561.

[T.D. 6610, 27 FR 8722, Aug. 31, 1962]

[[Page 624]]



Sec. 1.823-6  Determination of statutory underwriting income or loss.

    (a) In general. Section 823(a) and this section provide that for 
purposes of determining statutory underwriting income or loss for the 
taxable year, a mutual insurance company subject to the tax imposed by 
section 821(a) must first take into account the same gross income and 
deduction items (except as modified by section 823(b) and paragraph (c) 
of this section) as a taxpayer subject to tax under section 831 would 
take into account for purposes of determining its taxable income under 
section 832. These items are then reduced to the extent that they 
include amounts which are included in determining taxable investment 
income or loss under section 822(a) and Sec. 1.822-8. In addition, in 
computing its statutory underwriting income or loss for the taxable 
year, a company taxable under section 821(a) is allowed to deduct the 
amount determined under section 824(a) (relating to deduction to provide 
protection against losses) and, if its gross amount received is less 
than $1,100,000, is allowed to deduct the amount determined under 
section 823(c) and paragraph (d) of this section (relating to special 
deduction for certain small companies), subject to the limitations 
provided therein.
    (b) Definitions--(1) Statutory underwriting income defined. Section 
823(a) (1) defines the term ``statutory underwriting income'' for 
purposes of part II of subchapter L of the Code. Subject to the 
modifications provided by section 823(b) and paragraph (c) of this 
section, statutory underwriting income is defined as the amount by 
which:
    (i) The gross income which would be taken into account in computing 
taxable income under section 832 if the taxpayer were subject to the tax 
imposed by section 831, reduced by the gross investment income (as 
determined under section 822(b)), exceeds
    (ii) The sum of:
    (a) The deductions which would be taken into account in computing 
taxable income if the taxpayer were subject to the tax imposed by 
section 831, reduced by the deductions provided in section 822(c) 
(relating to deductions allowed in computing taxable investment income), 
plus
    (b) The deductions provided in section 823(c) (relating to special 
deduction for small company having gross amount of less than $1,100,000) 
and section 824(a) (relating to deduction to provide protection against 
losses).

For purposes of subdivision (ii)(a) of this subparagraph, the 
limitations on the amounts deductible under paragraphs (9) (relating to 
charitable, etc., contributions) and (12) (relating to partially tax-
exempt interest and to dividends received) of section 832(c) shall be 
computed by reference to taxable income as defined by section 832(a), 
and as modified by section 823(b) and paragraph (c) of this section.
    (2) Statutory underwriting loss defined. ``Statutory underwriting 
loss'' is defined in section 823(a)(2) as the amount by which the amount 
determined under section 823(a)(1)(B) and subparagraph (1)(ii) of this 
paragraph exceeds the amount determined under section 823(a)(1)(A) and 
subparagraph (1)(i) of this paragraph.
    (c) Modifications--(1) Net operating losses. In applying section 832 
for purposes of determining statutory underwriting income or loss under 
section 823(a) and paragraph (b) of this section, the deduction for net 
operating losses provided by section 172 is not allowed. However, see 
section 825(a) and Sec. 1.825-1 for unused loss deduction allowed 
companies taxable under section 821(a) in computing mutual insurance 
company taxable income under section 821(b).
    (2) Interinsurers and reciprocal underwriters--(i) In general. 
Section 823(b)(2) provides that in computing the statutory underwriting 
income or loss of a mutual insurance company which is an interinsurer or 
reciprocal underwriter, there shall be allowed as a deduction the 
increase for the taxable year in savings credited to subscriber 
accounts, or there shall be included as an item of gross income the 
decrease for the taxable year in savings credited to subscriber 
accounts. For purposes of this subparagraph, the term ``savings credited 
to subscriber accounts'' means such portion of the surplus for the 
taxable year as is credited to the individual accounts of subscribers 
before the 16th day of the third month following the close of the 
taxable year, but only

[[Page 625]]

if the company would be obligated to pay such amount promptly to such 
subscriber if he terminated his contract at the close of the company's 
taxable year, and only if the company mails notification to such 
subscriber of the amount credited to his individual account in the 
manner provided by subdivision (v) of this subparagraph.
    (ii) Limitations. Amounts representing return premiums (as defined 
in paragraph (a)(1)(ii) of Sec. 1.809-4) which the company would be 
obligated to pay to any subscriber terminating his contract at the close 
of the company's taxable year are not savings credited to subscriber 
accounts within the meaning of section 823(b)(2) and subdivision (i) of 
this subparagraph. The deduction for savings credited to individual 
subscriber accounts is allowed only in the case of reciprocal 
underwriters or interinsurers where the subscriber or policyholder has 
not only a legally enforceable right to receive the amount so credited 
if he withdraws from the exchange, but where the amounts credited, as a 
matter of actual practice, are paid to subscribers or policyholders who 
terminate their contracts. Thus, no deduction shall be allowed for 
savings credited to subscriber accounts if such savings are not in fact 
promptly returned to subscribers when they terminate their contracts.
    (iii) Computation of increase or decrease in savings credited to 
subscriber accounts. For purposes of determining the increase or 
decrease for the taxable year in savings credited to subscriber 
accounts, every reciprocal underwriter or interinsurer claiming a 
deduction under section 823(b)(2) and this section shall establish and 
maintain an account for savings credited to subscriber accounts. The 
opening balance in such account for the first taxable year for which a 
deduction is claimed under section 823(b)(2) and this section shall be 
zero. In each taxable year there shall be added to such account the 
total amount of savings credited to subscriber accounts for the taxable 
year, and there shall be subtracted from such account the total amount 
of savings subtracted from subscriber accounts for the taxable year. 
However, in no case may the amount added to the account exceed the total 
amount of savings to subscribers for the taxable year, irrespective of 
the amount of savings credited to subscriber accounts for the taxable 
year. Credits made to subscriber accounts after the close of the taxable 
year and before the 16th day of the third month following the close of 
the taxable year will be taken into account as if such amounts had been 
credited on the last day of the taxable year to the extent such amounts 
would have become fixed and determinable legal obligations due 
subscribers if such subscribers had terminated their contracts on the 
last day of the company's taxable year unless, at the time the amounts 
are credited, the company specifically designates such amounts as being 
from surplus for the taxable year in which the amounts were actually 
credited. Such a designation, once made, shall be irrevocable. However, 
if a company credited savings to subscriber accounts after December 31, 
1962, and before March 16, 1963, and failed to designate such credits as 
being from surplus for the taxable year 1963, such company may designate 
such credits as being from surplus for the taxable year 1963 for 
purposes of determining the total amount of credits to subscriber 
accounts for such year. In determining the total amount of savings 
subtracted from subscriber accounts for the taxable year, only amounts 
subtracted from savings credited for taxable years beginning with the 
first taxable year for which a deduction was claimed under section 
823(b)(2) and this subparagraph will be taken into account. The method 
of accounting regularly employed by the taxpayer in keeping its books of 
account will be used for purposes of determining whether the amounts 
subtracted from the subscriber accounts are from savings for taxable 
years beginning before the first taxable year for which a deduction is 
claimed under section 823(b)(2) and this subparagraph, or from savings 
for taxable years beginning with such first taxable year. Where the 
method of accounting regularly employed by the taxpayer in keeping its 
books of account does not clearly indicate whether an amount was 
subtracted from savings credited to subscriber accounts for taxable 
years beginning before the first taxable

[[Page 626]]

year for which a deduction is claimed under section 823(b)(2) and this 
subparagraph, or from savings credited for such first taxable year and 
subsequent taxable years, the amount subtracted will be deemed to have 
come from savings credited to subscriber accounts for all taxable years, 
on a pro rata basis. Where an amount is subtracted from a subscriber's 
account for record purposes, but such subtraction does not reflect the 
discharge of the company's legal obligation to pay the amount subtracted 
promptly to the subscriber if he terminates his contract, then such 
subtraction shall not be taken into account for purposes of section 
823(b)(2) and this subparagraph. On the other hand, where the company 
ceases to be under a legal obligation to pay promptly to any subscriber 
the amount credited to his individual account, then such amount shall be 
considered as having been subtracted from such subscriber's account at 
the time such obligation ceased to exist. For purposes of section 
823(b)(2) and this subparagraph, the increase (if any) for the taxable 
year in savings credited to subscriber accounts shall be the amount by 
which the balance in the account for savings credited to subscriber 
accounts as of the close of the taxable year exceeds the balance in such 
account as of the close of the preceding taxable year; and the decrease 
(if any) for the taxable year in savings credited to subscriber accounts 
shall be the amount by which the balance in the account for savings 
credited to subscriber accounts as of the close of the preceding taxable 
year exceeds the balance in such account as of the close of the taxable 
year.
    (iv) Legal obligation. For purposes of this subparagraph, the 
existence of a legal obligation on the part of the company to pay to the 
subscriber the savings credited to him will be determined under the 
insurance contract pursuant to which the credits are made. Where it 
appears that the company is otherwise legally obligated to pay amounts 
credited to its subscribers, the requisite legal obligation will not be 
considered absent merely because a subscriber's credits remain subject 
to absorption by future losses incurred if left on deposit with the 
company.
    (v) Notification to subscribers. Every reciprocal underwriter or 
interinsurer claiming a deduction under section 823(b)(2) and this 
subparagraph for amounts credited to the individual accounts of its 
subscribers must mail to each such subscriber written notification of 
the amount credited to the subscriber's account for the taxable year, 
the date on which such amount was credited, and the date on which the 
subscriber's right to such amount first would have become fixed if such 
subscriber had terminated his contract at the close of the company's 
taxable year. As an alternative to providing each subscriber with 
specific information relating to the amount of savings credited to his 
individual account, the notification required by this subdivision may be 
provided in the form of a table or formula mailed to the subscribers. 
However, a table or formula may not be used in lieu of the specific 
notification required by this subdivision unless such table or formula 
has been approved by the Commissioner. Generally, a table or formula 
will be approved if it enables the subscriber to simply and readily 
ascertain the amount of savings credited to his individual account for 
the taxable year, the date on which such amount was credited, and the 
date on which his right to such amount first would have become fixed if 
he had terminated his contract at the close of the company's taxable 
year. A reciprocal underwriter or interinsurer which desires to use such 
a table or formula should direct a written request for approval of such 
table or formula to the Commissioner of Internal Revenue, Attention: 
T:R, Washington, DC, 20224. Such request must set forth a copy of the 
table or formula proposed to be used, together with sufficient 
information to permit the Commissioner to determine the basis upon which 
such table or formula was prepared and the manner in which the 
subscribers will use such table or formula in determining the amounts 
credited to their individual accounts. Once a table or formula has been 
approved, the use of such table or formula with respect to savings 
credited for subsequent taxable years will not require further approval 
unless the basis upon which such table or formula

[[Page 627]]

was prepared, or the manner in which such table or formula is to be 
applied, is substantially changed. The table or formula method of 
notification may be used with respect to all or less than all of the 
company's subscribers. For example, the company might provide the 
notification required by this subdivision to one class of subscribers in 
the form of a table or formula mailed to the individual subscribers, 
while providing another class of subscribers with specific statements of 
the amounts credited to their individual accounts. The notification 
required by this subdivision must be mailed before the 16th day of the 
third month following the close of the reciprocal's taxable year for 
which the account was credited. Where for any taxable year a reciprocal 
underwriter or interinsurer claims a deduction under section 823(b) and 
this subparagraph and fails to give notice as required by this 
subdivision, such deduction shall not be allowed unless the reciprocal 
establishes to the satisfaction of the district director that the 
failure to mail such notice within the prescribed period was due to 
reasonable cause.
    (d) Special deduction for small company having gross amount of less 
than $1,100,000--(1) In general. In the case of a taxpayer subject to 
the tax imposed by section 821(a), section 823(c) provides that if the 
gross amount received during the taxable year from the items described 
in section 822(b) (other than paragraph (1)(D) thereof) and premiums 
(including deposits and assessments) is less than $1,100,000, then, 
subject to the limitation provided in section 823(c)(2) and subparagraph 
(2) of this paragraph, there shall be allowed an additional deduction 
for purposes of determining statutory underwriting income or loss under 
section 823(a) for the taxable year. The amount of the additional 
deduction is $6,000; except that if the gross amount received for the 
taxable year exceeds $500,000, the additional deduction is limited to an 
amount equal to 1 percent of the amount by which $1,100,000 exceeds such 
gross amount.
    (2) Limitation. The amount of the deduction provided by section 
823(c)(1) may not exceed the statutory underwriting income for the 
taxable year, computed without regard to the deduction allowed under 
section 823(c)(1) and subparagraph (1) of this paragraph, and the 
deduction allowed under section 824(a) (relating to deduction for 
protection against losses).
    (3) Example. The application of section 823(c) and this paragraph 
may be illustrated by the following example:

    M, a mutual insurance company subject to the tax imposed by section 
821(a), has the following items for the taxable year 1963:

Gross amount for purposes of section 823(c)(1)..............    $800,000
Gross investment income (including capital gains)...........     150,000
Capital gains...............................................     100,000
Gross income under section 832..............................     900,000
Deductions under section 822(c).............................      22,000
Deductions under section 832 (as modified by section                    
 823(b)(2)).................................................     746,000
                                                                        

    Under the provisions of section 823(c), M's special small company 
deduction for the taxable year 1963 would be $3,000, computed as 
follows:

(1) Gross amount for purposes of section 823(c)(1)..........    $800,000
(2) Amount by which $1,100,000 exceeds item (1) ($1,100,000             
 minus $800,000)............................................     300,000
(3) 1 percent of item (2) (not to exceed $6,000)............       3,000
(4) Gross income under section 832, reduced by gross                    
 investment income ($900,000 minus $150,000)................     750,000
(5) Deductions under section 832 (as modified by section                
 823(b)), reduced by deductions under section 822(c)                    
 ($746,000 minus $22,000)...................................     724,000
(6) Limitation on deduction under section 823(c) (1)                    
 (excess, if any, of item (4) over item (5))................      26,000
(7) Deduction under section 823(c)(1) (item (3) or item (6),            
 whichever is the lesser)...................................       3,000
                                                                        

[T.D. 6681, 28 FR 11116, Oct. 17, 1963]



Sec. 1.823-7   Subscribers of reciprocal underwriters and interinsurers.

    A subscriber or policyholder of a reciprocal underwriter or 
interinsurer entitled to the deduction allowed by section 823(b)(2) and 
paragraph (c)(2) of Sec. 1.823-6 shall treat amounts representing 
savings credit to his individual account for the taxable year as a 
dividend paid or declared for purposes of computing his taxable income. 
If a reciprocal credits savings to subscriber accounts after the close 
of its taxable year, but before the 16th day of the third month 
following the close of the taxable year, and the reciprocal takes such 
credits into account as if they had

[[Page 628]]

been made on the last day of its taxable year, the subscribers of such 
reciprocal must take such savings into account as if they had in fact 
been credited on the last day of the company's taxable year. The 
subscriber shall take savings credited to his account into account 
without regard to whether the amounts credited are actually distributed 
to him in cash. To the extent the insurance premium constituted a 
deductible expense when paid or accrued, the subscriber's taxable income 
for the taxable year will be increased and any loss for the taxable year 
will be decreased, by the amount credited to his account. Amounts 
credited to a subscriber's account which are taken into income by him 
and which subsequently are used to absorb losses of the reciprocal shall 
be treated by the subscriber as an additional insurance expense for the 
taxable year in which the amounts are absorbed. Such amounts may be 
deducted in computing taxable income to the extent insurance constitutes 
an otherwise properly deductible expense for such taxable year.

[T.D. 6681, 28 FR 11118, Oct. 17, 1963]



Sec. 1.823-8   Special transitional underwriting loss; cross reference.

    With respect to taxable years beginning after December 31, 1962, and 
before January 1, 1968, section 821(f) provides, for any company subject 
to the tax imposed by section 821(a), a special reduction in the 
statutory underwriting income if such company was subject to tax under 
section 821 for the five taxable years immediately preceding January 1, 
1962, and incurred an underwriting loss in each of such five taxable 
years. For rules relating to the determination of the amount of such 
reduction, see section 821(f) and Sec. 1.821-5.

[T.D. 6681, 28 FR 11118, Oct. 17, 1963]



Sec. 1.825-1   Unused loss deduction; in general.

    (a) Amount of deduction. Section 825(a) provides that the unused 
loss deduction of a mutual insurance company subject to the tax imposed 
by section 821(a) shall be an amount equal to the sum of the unused loss 
carryovers and carrybacks to the taxable year. The amount so determined 
is used in the computation of mutual insurance company taxable income 
for the taxable year. See section 821(b) and Sec. 1.821-4.
    (b) Unused loss defined. Section 825(b) defines the term ``unused 
loss'' as the amount (if any) by which:
    (1) The sum of the statutory underwriting loss (as defined in 
section 823(a)(2)) and the investment loss (as defined in section 
822(a)(2)) exceeds
    (2) The sum of:
    (i) The taxable investment income (as defined in section 822(a)(1)),
    (ii) The statutory underwriting income (as defined in section 
823(a)(1)), and
    (iii) The amounts required to be subtracted from the protection 
against loss account under section 824(d).
    (c) Steps in computation of unused loss deduction. The three steps 
to be taken in the ascertainment of the unused loss deduction for any 
taxable year are as follows:
    (1) Compute the unused loss for any preceding or succeeding taxable 
year from which an unused loss may be carried over or carried back to 
the taxable year.
    (2) Compute the unused loss carryovers to the taxable year from such 
preceding taxable years and the unused loss carrybacks to the taxable 
year from such succeeding taxable years.
    (3) Add such unused loss carryovers and carrybacks in order to 
determine the unused loss deduction for the taxable year.
    (d) Statement with tax return. Every mutual insurance company 
taxable under section 821(a) claiming an unused loss deduction for any 
taxable year shall file with its return for such year a concise 
statement setting forth the amount of the unused loss deduction claimed 
and all material and pertinent facts relative thereto, including a 
detailed schedule showing the computation of the unused loss deduction.
    (e) Ascertainment of deduction dependent upon unused loss carryback. 
If a mutual insurance company taxable under section 821(a) is entitled 
in computing its unused loss deduction to a carryback which it is not 
able to ascertain at the time its return is due, it

[[Page 629]]

shall compute the unused loss deduction on its return without regard to 
such unused loss carryback. When the company ascertains the unused loss 
carryback, it may within the applicable period of limitations file a 
claim for credit or refund of the overpayment, if any, resulting from 
the failure to compute the unused loss deduction for the taxable year 
with the inclusion of such carryback; or it may file an application 
under the provisions of section 6411 for a tentative carryback 
adjustment.
    (f) Law applicable to computations. The following rules shall apply 
to taxable years for which the taxpayer is subject to the tax imposed by 
section 821(a):
    (1) In determining the amount of any unused loss carryback or 
carryover to any taxable year, the necessary computations involving any 
other taxable year shall be made under the law applicable to such other 
taxable year.
    (2) The unused loss for any taxable year shall be determined under 
the law applicable to that year without regard to the year to which it 
is to be carried and in which, in effect, it is to be deducted as part 
of the unused loss deduction.
    (3) The amount of the unused loss deduction which shall be allowed 
for any taxable year shall be determined under the law applicable for 
that year.

[T.D. 6681, 28 FR 11122, Oct. 17, 1963]



Sec. 1.825-2   Unused loss carryovers and carrybacks.

    (a) Years to which loss may be carried--(1) In general. In order to 
determine its unused loss deduction for any taxable year, a mutual 
insurance company taxable under section 821(a) must first determine the 
part of any unused losses for any preceding or succeeding taxable years 
which are carryovers or carrybacks to the taxable year in issue. An 
unused loss is to be an unused loss carryback to each of the 3 taxable 
years preceding the loss year, and an unused loss carryover to each of 
the 5 taxable years following the loss year, subject to the limitations 
provided in section 825(g) and subparagraph (2) of this paragraph.
    (2) Limitations. An unused loss may not be carried:
    (i) To or from any taxable year beginning before January 1, 1963,
    (ii) To or from any taxable year for which the taxpayer is not 
subject to the tax imposed by section 821(a), nor
    (iii) To any taxable year if, between the loss year and such taxable 
year, there is an intervening taxable year for which the taxpayer was 
not subject to the tax imposed by section 821(a).
    (3) Periods of less than 12 months. A fractional part of a year 
which is a taxable year under sections 441(b) and 7701(a)(23) is a 
preceding or a succeeding taxable year for the purpose of determining 
under section 825 the first, second, etc., preceding or succeeding 
taxable year.
    (b) Loss year defined. The term ``loss year'' as used in this 
section means any taxable year for which a company subject to the tax 
imposed by section 821(a) has an unused loss in excess of zero.
    (c) Amount of carrybacks and carryovers. Section 825(e) provides 
that in the case of a loss year for a company taxable under section 
821(a), the entire amount of the unused loss shall be carried to the 
earliest taxable year to which such loss may be carried under section 
825(d) (subject to the limitations of section 825(g)). The amount of the 
unused loss carried to each of the other taxable years to which such 
loss may be carried under section 825(d) following such earliest taxable 
year shall be the excess (if any) of such loss over the sum of the 
offsets for each taxable year preceding the taxable year to which the 
unused loss is carried.
    (d) Offset defined--(1) In general. Section 825(f) defines the term 
``offset'' and provides that the taxable year to which an unused loss is 
carried shall be referred to as the ``offset year''. The definition of 
the term offset in the case of an unused loss carryback to an offset 
year, differs from the definition of such term in the case of an unused 
loss carryover to an offset year.
    (2) Offset in case of carryback. In the case of an unused loss 
carryback from the loss year to the offset year, the offset is the 
mutual insurance company taxable income for the offset year, computed 
without regard to any unused loss carryback from the loss year or any 
taxable year thereafter.

[[Page 630]]

    (3) Offset in case of carryover. In the case of an unused loss 
carryover from the loss year to the offset year, the offset is equal to 
the sum of:
    (i) The amount required to be subtracted from the protection against 
loss account under section 824(d)(1)(C) (relating to amounts equal to 
the unused loss carryovers to the offset year), plus
    (ii) The mutual insurance company taxable income for the taxable 
year, computed without regard to any unused loss carryback or carryover 
from the loss year or any taxable year thereafter.

[T.D. 6681, 28 FR 11123, Oct. 17, 1963]



Sec. 1.825-3   Examples.

    The application of section 825 may be illustrated by the following 
examples:

    Example 1. For the taxable year 1967, F, a mutual insurance company 
subject to the tax imposed by section 821(a), has the following items:

Taxable investment income....................................          1
Underwriting loss............................................         59
Addition to protection against loss account..................          8
Statutory underwriting loss..................................         67
                                                                        

    The subtractions from the protection against loss account are as 
follows:


Amount subtracted from amounts in account with respect to               
 taxable years 1963 through 1966.............................         18
Amount subtracted from amounts in account with respect to               
 taxable year 1967...........................................          8
                                                              ----------
Total subtractions from protection against loss account under           
 section 824(d)..............................................         26
                                                                        

    The application of section 825 in this case may be illustrated by 
the facts and results shown in the following table and explained below:

                                                  Taxable Year                                                  
----------------------------------------------------------------------------------------------------------------
                                                        1963      1964      1965      1966      1967      1968  
----------------------------------------------------------------------------------------------------------------
Protection against loss account:                                                                                
  Addition to account during taxable year...........         6         2         3         7         8         7
  Subtraction from account during taxable year......         0         0         0         0         8         7
      Protection against loss account (at end of                                                                
       year)........................................         6         2         3         7         0         0
      Protection against loss account (at end of                                                                
       taxable year 1968)...........................         0         0         0         0         0         0
Unused loss.........................................         0         0         0         0        40         0
Unused loss carryback...............................         0        40        35        25         0         0
Unused loss carryover...............................         0         0         0         0         0        18
Unused loss deduction...............................         0        40        35        25         0        18
Mutual insurance company taxable income (computed                                                               
 without regard to unused loss).....................        13         5        10         7         0         2
Mutual insurance company taxable income (computed                                                               
 with regard to unused loss)........................        13         0         0         0         0         0
Offset for year.....................................         0         5        10         7         0         9
Offset total........................................         0         5        15        22        22        31
----------------------------------------------------------------------------------------------------------------

    1967: Under the provisions of section 825(b), F's unused loss for 
1967 is 40, the amount by which the sum of the statutory underwriting 
loss and the investment loss, 67 (67 plus 0), exceeds the sum of the 
taxable investment income, the statutory underwriting income, and the 
amounts required to be subtracted from the protection against loss 
account under section 824(d) for the taxable year, 27 (the sum of 1, 0, 
and 26, respectively).
    1967 carryback to 1964: Under the provisions of section 825(e), the 
entire unused loss for 1967 of 40 is carried back to 1964, the earliest 
year to which the loss may be carried under section 825(d). Since there 
are no other amounts carried to 1964, the unused loss deduction for 1964 
is 40. Thus, after taking the unused loss deduction into account, the 
mutual insurance company taxable income for 1964 is zero, and the offset 
for 1964 is 5 (the mutual insurance company taxable income for 1964 
determined without regard to the unused loss carryback from 1967 or any 
year thereafter).
    1967 carryback to 1965: The portion of the unused loss for 1967 
which is carried back to 1965 is 35 (40 minus 5, the offset for 1964). 
After taking the unused loss deduction into account, the mutual 
insurance company taxable income for 1965 is zero. The offset for 1965 
is 10, the mutual insurance company taxable income for 1965 determined 
without regard to any unused loss carryback from 1967 or any year 
thereafter.
    1967 carryback to 1966: The portion of the unused loss for 1967 
which is carried back to 1966 is 25. This amount is the excess of the 
unused loss for 1967 of 40 over the sum of the offset for 1964 (5) and 
the offset for 1965 (10). As a result of the unused loss deduction the 
mutual insurance company taxable income

[[Page 631]]

for 1966 is reduced to zero. The offset for 1966 is 7.
    1967 carryover to 1968: Under the provisions of section 825(d), the 
portion of the unused loss for 1967 which is carried forward to 1968 is 
18 (40 minus the sum of 5, 10, and 7, the offsets for 1964, 1965, and 
1966, respectively). Under section 825(f)(2), this amount is first 
applied against any amounts in the protection against loss account at 
the end of 1968, and is then applied against the mutual insurance 
company taxable income for 1968 (computed without regard to any unused 
loss carryovers or carrybacks from 1967 or any taxable year thereafter). 
Thus, assuming that there are no other subtractions from its protection 
against loss account under section 824(d) for 1968, F's protection 
against loss account of 7 is reduced to zero by reason of the 
subtraction under section 824(d)(1)(C). The remaining portion of the 
unused loss for 1967 which is carried to 1968, 11 (18 minus 7, the 
amount of the unused loss carryover to 1968 which is subtracted from the 
protection against loss account under section 824(d)(1)(C)), is then 
applied against the mutual insurance company taxable income for 1968 
computed without regard to any unused carryback or carryover from the 
loss year (1967) or any taxable year thereafter. After the application 
of the unused loss deduction for 1968, the mutual insurance company 
taxable income for 1968 is zero. The offset for 1968 is 9, the sum of 
the amount required to be subtracted from the protection against loss 
account under section 824(d)(1)(C) for 1968 (7), plus the mutual 
insurance company taxable income for 1968, determined without regard to 
any unused loss carryover or carryback from 1967 or any year thereafter 
(2). The remaining 9 of the unused loss for 1967 (40 minus the sum of 5, 
10, 7, and 9, the offsets for 1964, 1965, 1966, and 1968, respectively), 
is carried forward to 1969, and to the extent not used in that year or 
any year thereafter, may be carried forward to 1970, 1971, and 1972, in 
that order.
    Example 2. If in example 1 F had an unused loss in 1966 of 22, then, 
with respect to F's 1967 unused loss of 40, the offset for 1964 would be 
zero; the offset for 1965 would be 6--the 1965 mutual insurance company 
taxable income of 10 less an unused loss carryback of 4 from 1966 (the 
1966 unused loss of 22 minus the 1963 offset of 13 and the 1964 offset 
of 5); the offset for the loss year 1966 would be zero, and 34 (the 1967 
unused loss of 40 minus the offset for 1965 of 6) would remain as an 
unused loss carryover to 1968, 1969, 1970, 1971, 1972, in that order. 
Thus, the unused loss carrybacks or carryovers to an offset year are 
applied against the mutual insurance company taxable income for such 
year in the order in which the losses occurred, with the earliest loss 
being offset first.
    Example 3. For the taxable year 1963, M, a mutual insurance company 
subject to tax imposed by section 821(a), has an unused loss (as defined 
in section 825(b)) of $65,000. Under section 825(g), the loss may not be 
carried back to any taxable year beginning before 1963. However, the 
loss may be carried forward to each of the 5 taxable years following 
1963 provided that for each of such succeeding taxable years M is 
subject to the tax imposed by section 821(a).
    Example 4. Assume the facts are the same as in example 3, except 
that for the taxable year 1964, the gross amount received by M from the 
items described in section 822(b) (other than paragraph (1)(D) thereof) 
and premiums (including deposits and assessments) exceeds $150,000 but 
does not exceed $500,000. If M does not make the election under section 
821(d) (relating to election to be taxed under section 821(a)) for 1964, 
M's 1963 unused loss of $65,000 will not be allowed as an unused loss 
carryover or carryback since, by reason of section 825(g)(3), the unused 
loss may not be carried to any taxable year if, between the loss year 
and such taxable year, there is an intervening taxable year for which 
the insurance company was not subject to the tax imposed by section 
821(a), and by reason of section 825(g)(1), the unused loss may not be 
carried to any taxable year beginning before 1963.

[T.D. 6681, 28 FR 11123, Oct. 17, 1963]



Sec. 1.826-1   Election by reciprocal underwriters and interinsurers.

    (a) In general. Except as otherwise provided in section 826(c), any 
mutual insurance company which is an interinsurer or reciprocal 
underwriter taxable under section 821(a) may elect under section 826(a) 
to limit its deductions for amounts paid or incurred to its attorney-in-
fact to the deductions of its attorney-in-fact which are allocable to 
income received by the attorney-in-fact from the reciprocal during the 
taxable year. See Sec. 1.826-4 for rules relating to allocation of 
expenses. In no case may such an election increase the amount deductible 
by the reciprocal for amounts paid or due its attorney-in-fact for the 
taxable year. The election allowed by section 826(a) and this section in 
effect increases the income of the reciprocal by the net income of the 
attorney-in-fact attributable to its business with the reciprocal. A 
reciprocal making the election is allowed a credit for the amount of tax 
paid by the attorney-in-fact for the taxable year which is attributable 
to income received by the attorney-in-

[[Page 632]]

fact from the reciprocal. See section 826(e) and Sec. 1.826-5.
    (b) Companies eligible to elect under section 826(a). Any mutual 
insurance company which is a reciprocal underwriter or interinsurer 
subject to the tax imposed by section 821(a) may elect (in the manner 
prescribed by paragraph (c) of this section) to be subject to the 
limitation provided by section 826(b) and paragraph (a) of this section 
provided the attorney-in-fact of the electing reciprocal:
    (1) Is subject to the taxes imposed by section 11 (b) and (c) and 
the regulations thereunder;
    (2) Consents (in the manner provided by paragraph (a) of Sec. 1.826-
3) to provide the information required under paragraph (b) of 
Sec. 1.826-3 during the period in which the election made under section 
826(a) and this section is in effect;
    (3) Reports the income received from the reciprocal and the 
deductions allocable thereto under the same method of accounting used by 
the reciprocal in reporting its deductions for amounts paid or due its 
attorney-in-fact; and
    (4) Files its income tax return on a calendar year basis.
    (c) Manner of making election. The election provided by section 
826(a) and this section shall be made in a statement attached to the 
taxpayer's income tax return for the first taxable year for which such 
election is to apply. The statement shall include the name and address 
of the taxpayer, shall be signed by the taxpayer (or its duly authorized 
representative), and shall be filed not later than the time prescribed 
by law for filing the income tax return (including extensions thereof) 
for the first taxable year for which such election is to apply. For 
information required of an electing reciprocal, see paragraph (e) of 
this section.
    (d) Scope of election. The election allowed by section 826(a) is 
binding for the taxable year for which made and all succeeding taxable 
years unless the Commissioner consents to a revocation of such election. 
Whether revocation will be permitted will depend upon the facts and 
circumstances of each particular case.
    (e) Information required of an electing company. Every reciprocal 
underwriter or interinsurer making the election provided by section 
826(a) and this section shall, in the manner provided by paragraph (f) 
of this section, furnish the following information for each taxable year 
during which such election is in effect:
    (1) The name and address of the attorney-in-fact with respect to 
which the election allowed by section 826(a) and this section is in 
effect; the district in which such attorney-in-fact filed its return for 
the taxable year; and a copy of the consent required by section 826 and 
Sec. 1.826-3 and the date and district in which such consent was filed;
    (2) The deductible amount paid or due to such attorney-in-fact from 
the reciprocal computed without regard to the limitation provided by 
section 826(b);
    (3) The total amount claimed as a deduction by the reciprocal for 
amounts paid to its attorney-in-fact after giving effect to the 
limitation provided by section 826(b);
    (4) The amount of the increase (if any) in underwriting gain (as 
defined in section 824(a)) attributable to the election allowed by 
section 826(a);
    (5) The amount of the increase (if any) in the deduction allowed by 
section 824(a) (relating to deduction to provide protection against 
losses) attributable to the election allowed by section 826(a);
    (6) The amount of any increase or decrease in the statutory 
underwriting income or loss for the taxable year (as computed under 
section 823) attributable to the election allowed by section 826(a);
    (7) The amount of any increase or decrease in the mutual insurance 
company taxable income or unused loss for the taxable year attributable 
to the election allowed by section 826(a);
    (8) The amount of the increase (if any) in the tax liability of the 
reciprocal for the taxable year attributable to the election allowed by 
section 826(a) before taking into account the credit provided by section 
826(e);
    (9) The amount of tax attributable to income received by the 
attorney-in-fact from the reciprocal during the taxable year (as 
determined under Sec. 1.826-5) claimed (under section 826(e) and

[[Page 633]]

paragraph (a) of this section) by the reciprocal as a credit for the 
taxable year; and
    (10) The information which the attorney-in-fact is required to 
submit to the reciprocal under paragraphs (b) and (c) of Sec. 1.826-3.
    (f) Manner in which information is to be provided. The information 
required by paragraph (e) of this section shall be set forth in a 
statement attached to the taxpayer's income tax return for each taxable 
year for which such information is required. Such statement shall 
include the name and address of the taxpayer; and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the income tax return for the taxable year with respect to which 
such information is being provided.

[T.D. 6681, 28 FR 11124, Oct. 17, 1963]



Sec. 1.826-2   Special rules applicable to electing reciprocals.

    (a) Protection against loss account. Section 826(d) provides that 
for purposes of determining the amount to be subtracted from the 
protection against loss account under section 824(d)(1)(D) and the 
regulations thereunder (relating to amounts added to the account for the 
fifth preceding taxable year) for any taxable year, any amount which was 
added to such account by reason of the election under section 826(a) and 
paragraph (a) of Sec. 1.826-1 shall be treated as having been added by 
reason of section 824(a)(1)(A) and the regulations thereunder (relating 
to amounts equal to 1 percent of losses incurred during the taxable 
year). Thus, no amount added to the protection against loss account by 
reason of an election made under section 826(a) may remain in such 
account beyond the end of the fifth taxable year following the taxable 
year with respect to which such amount was added. See section 
824(d)(1)(D) and paragraph (b)(3) of Sec. 1.824-1. The amount added to 
the protection against loss account by reason of an election under 
section 826(a) is that amount which is equal to 25 percent (plus, in the 
case of a reciprocal which qualifies as a concentrated risk company 
under section 824(a), so much of the concentrated wind-storm, etc., 
premium percentage as exceeds 40 percent) of the amount by which:
    (1) The underwriting gain (as defined by section 824(a)(1)) computed 
after taking into account the limitation provided by section 826(b) and 
Sec. 1.826-1, exceeds
    (2) The underwriting gain computed without regard to the limitation 
provided by section 826(b) and Sec. 1.826-1.
    (b) Denial of surtax exemption. Section 826(f) provides that the tax 
imposed upon any increase in the mutual insurance company taxable income 
of a reciprocal which is attributable to the limitation provided by 
section 826(b) shall be computed without regard to the surtax exemption 
provided by section 821(a)(2) and the regulations thereunder. Thus, a 
company making the election provided under section 826(a) will be 
subject to surtax, as well as normal tax, on the increase in its mutual 
insurance company taxable income for the taxable year which is 
attributable to such election. Similarly, any amount which was added to 
the protection against loss account by reason of an election under 
section 826(a) and Sec. 1.826-1, and which is subtracted from such 
account in accordance with section 826(d) and paragraph (a) of this 
section, will be subject to surtax, as well as normal tax, to the extent 
such amount increases mutual insurance company taxable income in the 
year in which the subtraction is made. Furthermore, the company will be 
subject to surtax on such increases notwithstanding the fact that it may 
have no normal tax liability for the taxable year, because its mutual 
insurance company taxable income (after giving effect to the election 
provided by section 826(a)) does not exceed $6,000.
    (c) Adjustment for refunds. Section 826(g) provides that if for any 
taxable year an attorney-in-fact is allowed a credit or refund for taxes 
paid with respect to which credit or refund to the reciprocal resulted 
under section 826(e), the taxes of such reciprocal for such taxable year 
shall be properly adjusted. The reciprocal shall make the adjustment 
required by section 826(g) by increasing its income tax liability for 
its taxable year in which the credit or refund is allowed to the 
attorney-in-fact by the amount of such credit or refund

[[Page 634]]

which is attributable to taxes paid by the attorney-in-fact on income 
received from the reciprocal, as determined under Sec. 1.826-6, but only 
to the extent that the payment of such amount by the attorney-in-fact 
resulted in a credit or refund to the reciprocal. However, if the refund 
or credit to the attorney-in-fact is the result of an error in 
determining its items of income or deduction for the taxable year with 
respect to which the refund or credit is allowed, and such error affects 
the amount of deductions allocable to its reciprocal for such taxable 
year, then, if the reciprocal's period for filing an amended return has 
not otherwise expired, the preceding sentence shall not apply and the 
reciprocal shall make the adjustment required by section 826(g) by 
filing an amended return for such taxable year and all subsequent 
taxable years for which an adjustment is required. The reciprocal's 
amended return or returns shall give effect to the change in the 
deductions of the attorney-in-fact allocable to income received from the 
reciprocal and the tax paid by the attorney-in-fact attributable to such 
income. The amount of any adjustment required by section 826(g) and this 
section and the computation thereof shall be set forth in a statement 
attached to and filed with the taxpayer's income tax return for the 
taxable year for which the adjustment is made. Such statement shall 
include the name and address of the taxpayer, and a copy of the 
notification received by the attorney-in-fact indicating that it has 
been allowed the credit or refund requiring adjustment of the 
reciprocal's taxes.

[T.D. 6681, 28 FR 11125, Oct. 17, 1963, as amended by T.D. 7100, 36 FR 
5334, Mar. 20, 1971]



Sec. 1.826-3   Attorney-in-fact of electing reciprocals.

    (a) Manner of making consent. Section 826(c)(2) provides that a 
reciprocal may not elect to be subject to the limitation provided by 
section 826(b) unless its attorney-in-fact consents to make certain 
information available. See paragraph (b) of this section. The attorney-
in-fact of a reciprocal making the election provided by section 826(a) 
shall signify the consent required by section 826(c) in a statement 
attached to its income tax return for the first taxable year for which 
the reciprocal's election is to apply. Such statement shall include the 
name and address of the consenting taxpayer; the name and address of the 
reciprocal with respect to which such consent is to apply; shall be 
signed by the taxpayer (or its duly authorized representative); and 
shall be filed not later than the date prescribed by law (including 
extensions thereof) for filing the income tax return for the first 
taxable year for which such consent is to apply. In addition, such 
statement shall specify that the taxpayer is subject to the taxes 
imposed by section 11 (b) and (c); the method of accounting used in 
reporting income received from its reciprocal and the deductions 
allocable thereto; and that its return is filed on the calendar year 
basis. Consent, once given, shall be irrevocable for the period during 
which the election provided for the reciprocal by section 826(a) is in 
effect. See paragraph (e) of Sec. 1.826-1.
    (b) Information required of consenting attorney-in-fact. Every 
attorney-in-fact making the consent provided by section 826(c)(2) and 
paragraph (a) of this section shall, in the manner prescribed by 
paragraph (c) of this section, furnish the following information for 
each taxable year during which the consent provided by section 826(c)(2) 
and paragraph (a) of this section is in effect:
    (1) The name and address of the reciprocal with respect to which the 
consent required by section 826(c)(2) and paragraph (a) of this section 
is to apply;
    (2) Gross income in total and by sources, adjusted for returns and 
allowances;
    (3) Deductions (itemized to the same extent as on taxpayer's income 
tax return and accompanying schedules) allocable to each source of gross 
income and in total (see Sec. 1.826-4);
    (4) Method of allocation used in subparagraph (3) of this paragraph;
    (5) Taxable income (if any) in total and by sources, as in 
subparagraph (2) of this paragraph (income by sources from subparagraph 
(2) of this paragraph minus expenses allocable thereto under 
subparagraph (3) of this paragraph);

[[Page 635]]

    (6) Total income tax liability (if any) for the taxable year;
    (7) Taxes paid attributable (under Sec. 1.826-5) to income earned by 
the taxpayer in dealing with the reciprocal;
    (8) Such other information as may be required by the district 
director.
    (c) Manner in which information is to be provided. (1) The 
information required by paragraph (b) of this section shall be set forth 
in a statement attached to the taxpayer's income tax return for each 
taxable year for which the consent provided by section 826(c)(2) and 
paragraph (a) of this section is in effect. Such statement shall include 
the name and address of the taxpayer, and shall be filed not later than 
the date prescribed by law (including extensions thereof) for filing the 
income tax return for each taxable year for which such information is 
required.
    (2) A copy of the statement containing the information required by 
paragraph (b) of this section shall be submitted to the board of 
advisors (or other comparable body) of the reciprocal on whose behalf 
the consent provided under section 826(c)(2) is given. The copy shall be 
executed in the same manner as the original and shall be delivered to 
such board not later than 10 days before the last date prescribed by law 
(including extensions thereof) for filing the reciprocal's income tax 
return for the taxable year for which the information is required unless 
the attorney-in-fact establishes to the satisfaction of the district 
director that the failure to furnish such copy or the failure to furnish 
such copy within the prescribed 10 day period was due to circumstances 
beyond its control. In addition, there shall be attached to and made a 
part of such copy, a copy of the income tax return of the attorney-in-
fact (including accompanying schedules) for each taxable year for which 
such statement is required.

[T.D. 6681, 28 FR 11125, Oct. 17, 1963]



Sec. 1.826-4   Allocation of expenses.

    An attorney-in-fact allocating expenses as required by section 
826(b) and paragraph (b) of Sec. 1.826-3 shall allocate each expense 
itemized in its income tax return (and accompanying schedules) for the 
taxable year to each source of gross income (as set forth pursuant to 
paragraph (b)(2) of Sec. 1.826-3). However, no portion of the net 
operating loss deduction allowed by section 172 shall be allocated to 
income received or due from the reciprocal, and no expenses, other than 
those directly related thereto, shall be allocated to capital gains. 
Where the method of allocation used by the taxpayer does not reasonably 
reflect the expenses of the taxpayer allocable to income received or due 
from the reciprocal, the district director may require the taxpayer to 
use such other method of allocation as is reasonable under the 
circumstances.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-5   Attribution of tax.

    (a) In general. Section 826(e) provides that a reciprocal making the 
election allowed by section 826(a) shall be credited with so much of the 
tax paid by the attorney-in-fact as is attributable to the income 
received by the attorney-in-fact from the reciprocal in such taxable 
year.
    (b) Computation. For purposes of section 826(e) and paragraph (a) of 
this section, the amount of tax attributable to income received by the 
attorney-in-fact from the reciprocal in the taxable year shall be 
computed in the following manner:
    (1) First, compute the taxable income (if any) from each source of 
gross income set forth in paragraph (b)(2) of Sec. 1.826-3 by deducting 
from each such amount the expenses allocable thereto under Sec. 1.826-4;
    (2) Second, compute the normal tax on each amount of taxable income 
computed in subparagraph (1) of this paragraph at the rate provided by 
section 11(b) of the Code;
    (3) Third, deduct from each amount determined in subparagraph (1) of 
this paragraph an amount which bears the same proportion to the surtax 
exemption provided by section 11(c) of the Code as each amount computed 
under subparagraph (1) of this paragraph bears to the total of the 
amounts computed under subparagraph (1) of this paragraph;
    (4) Fourth, compute the surtax on each remainder computed in 
subparagraph (3) of this paragraph at the rate provided by section 11(c) 
of the Code;

[[Page 636]]

    (5) Fifth, add the normal tax computed under subparagraph (2) of 
this paragraph to the surtax computed under subparagraph (4) of this 
paragraph for each amount computed under subparagraph (1) of this 
paragraph;
    (6) Sixth, deduct from each amount of tax computed under 
subparagraph (5) of this paragraph any tax credits (other than those 
arising from payments made with respect to the tax liability for the 
taxable year or other taxable years) allocable (in the same manner as 
provided for expenses under Sec. 1.826-4) to such amount;
    (7) Seventh, compute that amount which bears the same proportion to 
the tax actually paid with respect to the taxable year as each 
individual amount computed under subparagraph (6) of this paragraph 
bears to the total of the amounts computed under subparagraph (6) of 
this paragraph. The amount so determined with respect to each amount 
computed under subparagraph (6) of this paragraph is the tax paid which 
is attributable to the amount computed under subparagraph (1) of this 
paragraph.

To the extent the amounts determined under subparagraph (1) of this 
paragraph are attributable to amounts received from the reciprocal for 
the taxable year, the tax attributable to such amounts (as determined 
under subparagraph (7) of this paragraph) shall be the amount of tax 
attributable to income received by the attorney-in-fact from the 
reciprocal during the taxable year.
    (c) Taxes of attorney-in-fact unaffected. Nothing in section 826 or 
the regulations thereunder shall increase or decrease the taxes imposed 
on the income of the attorney-in-fact.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-6   Credit or refund.

    (a) Notification required. In any case where a taxpayer applies for 
a credit or refund of taxes paid by it in respect of a taxable year for 
which the taxpayer was the consenting attorney-in-fact of a reciprocal 
making the election provided by section 826(a), such taxpayer shall give 
notice to its reciprocal for such taxable year, first, upon applying for 
the credit or refund; and again, within 10 days from the date on which a 
final determination is made that such credit or refund has been allowed 
or denied.
    (b) Notice form. The notices required by this section shall include 
the name and address of the taxpayer and shall be signed by the taxpayer 
or its duly authorized representative. In addition, there shall be 
attached to and made a part of each first notice a concise statement of 
the claim upon which the application for refund or credit is based; and 
there shall be attached to and made a part of each second notice:
    (1) A copy of the notification (if any) received by the taxpayer 
indicating that the credit or refund has been allowed; and
    (2) A statement setting forth the amount of such credit or refund 
attributable to taxes paid by the taxpayer on income received from the 
reciprocal, and the computation by which such amount was determined.
    (c) Manner of apportioning refund or credit. The taxpayer shall 
determine the amount of the refund or credit attributable to taxes paid 
on income received from its reciprocal by reallocating its income and 
expense items for the taxable year, with respect to which the refund or 
credit is allowed, in the manner provided by Secs. 1.826-3 and 1.826-4 
so as to reflect the adjustments (if any) in such items which resulted 
in the credit or refund of tax for the taxable year. The taxpayer shall 
then recompute the tax attributable to income received from its 
reciprocal for such taxable year in the manner provided by Sec. 1.826-5. 
The district director may require such additional information as may be 
necessary in the circumstances to verify the computations required by 
this paragraph.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]



Sec. 1.826-7   Examples.

    The application of section 826 may be illustrated by the following 
examples:

    Example 1. For the taxable year 1963, R, a reciprocal underwriter 
subject to the taxes imposed by section 821(a), has the following items 
(determined before applying any election under section 826):

Gross income under sec. 832..................................       $578
Gross investment income......................................         50
                                                   ============         

[[Page 637]]

                                                                        
Deductions under sec. 832 (as modified by sec.                          
 823(b)):                                                               
    Deduction for amounts paid by R to attorney-in-                     
     fact A.......................................       $100           
    All other deductions..........................        500           
                                                   ===========          
      Total deductions under sec. 832.............        600           
Deductions under sec. 822(c).................................         40
Incurred losses..............................................        400
Protection against loss deduction............................          4
Underwriting gain............................................          0
Mutual insurance company taxable income......................          0
Unused loss..................................................         22
Credit or refund for taxes paid..............................          0
                                                                        

Assume that the deductions of attorney-in-fact A allocable to the income 
received by A from R are 60 and the tax paid by A allocable to the 
income received from R is 16. If R elects to be subject to the 
limitation provided in section 826(b), the results for 1963 would be as 
follows:

Gross income under sec. 832..................................       $578
Gross investment income......................................         50
                                                   ============         
Deductions under sec. 832 (as modified by sec.                          
 823(b)):                                                               
    Deduction for amounts paid by R to attorney-in-                     
     fact A.......................................        $60           
    All other deductions..........................        500           
                                                   ===========          
      Total deduction under sec. 832..............       560            
Deductions under sec. 822(c).................................         40
Incurred losses..............................................        400
Underwriting gain............................................          8
Protection against loss deduction............................          6
Mutual insurance company taxable income......................         12
Unused loss..................................................          0
Credit or refund for taxes paid..............................         16
                                                                        

    Under the provisions of section 826(b), R's deduction for amounts 
paid or incurred to the attorney-in-fact in the taxable year 1963 would 
be limited to the deductions of A allocable to the income received by A 
from R. Thus, R's deductions under section 832 (as modified by section 
823(b)) for 1963 would be 60 (the deductions of A which are allocable to 
the income received by A from R). As a result of making the election 
under section 826(a) for the taxable year 1963, R's underwriting gain 
would be 8, and its statutory underwriting income would be 2 (the 
underwriting gain of 8 minus the protection against loss deduction of 
6--of which 4 represents the amount determined under section 
824(a)(1)(A)--and 2 represents the amount determined under section 
824(a)(1)(B)--or 8 minus 6). R's mutual insurance company taxable income 
for 1963 would be 12, consisting of taxable investment income of 10 
(gross investment income minus deductions under section 822(c), or 50 
minus 40) plus statutory underwriting income of 2. Since all of R's 
mutual insurance company taxable income of 12 is attributable to the 
limitation under section 826(b), the entire amount is subject to the 
surtax under section 821(a)(2) without regard to the $25,000 surtax 
exemption. The credit of 16, representing that part of the tax paid by A 
which is allocable to the income received by A from R, may be applied by 
R against its taxes with respect to its mutual insurance company taxable 
income of 12 for 1963, and R would be entitled to a refund of any excess 
of the amount of such credit over its tax liability for 1963.
    Under the provisions of section 826(d), no portion of the amount 
added to the protection against loss account in 1963 by reason of the 
election under section 826(a), 2 (25 percent of the amount by which the 
consolidated underwriting gain exceeds 25 percent of the underwriting 
gain determined without regard to the election under section 826(a), or 
the amount by which 25 percent of 8 exceeds 25 percent of 0), may remain 
in such account beyond the taxable year 1968.
    Example 2. For the taxable year 1963, F is a corporate attorney-in-
fact subject to the taxes imposed by section 11(b) and (c) of the Code. 
F files its return on the calendar year basis and reports income 
received from its reciprocal and the deductions allocable thereto under 
the same method of accounting used by its reciprocal in reporting its 
deductions for amounts paid to R. F properly consents to provide the 
information required by paragraph (b) of Sec. 1.826-3. In addition to 
its attorney-in-fact business, F owns real estate for investment 
purposes, and operates a real estate management service. For the taxable 
year 1963, F has gross income from these various sources as follows:

Attorney-in-fact fees............................................$85,000
Real estate management fees.......................................18,000
Rental income.....................................................25,000

F allocates its expenses for the taxable year on the basis of their 
direct relation to each source of income. During 1963, F acquired 
property for use in its attorney-in-fact operations which entitled F to 
an investment credit of $800 under section 38. For 1963, F determines 
that the tax paid by it which is attributable to its reciprocal is 
$21,863, computed as follows:

----------------------------------------------------------------------------------------------------------------
                                                                     Attorney-     Real                         
                                                                      in-fact     estate      Rental     Total  
                                                                        fees    management    income            
----------------------------------------------------------------------------------------------------------------
Gross income.......................................................    $85,000     $18,000    $25,000   $128,000
Allocable expenses.................................................     25,000       3,000     35,000     63,000
Taxable income (loss)..............................................     60,000      15,000   (10,000)     65,000
Normal tax (30 percent)............................................     18,000       4,500          0     19,500
Surtax exemption...................................................     20,000       5,000          0     25,000
Income subject to surtax...........................................     40,000      10,000          0     40,000

[[Page 638]]

                                                                                                                
Surtax (22 percent)................................................      8,800       2,200          0      8,800
Total tax..........................................................     26,800       6,700          0     28,300
Investment credit..................................................        800           0          0        800
1963 tax liability.................................................     26,000       6,700          0     27,500
1963 tax paid......................................................  .........  ..........  .........     27,500
Allocation of tax paid.............................................     21,863       5,637          0     27,500
----------------------------------------------------------------------------------------------------------------

Under paragraph (b)(1) of Sec. 1.826-5, F computes its taxable income 
from its attorney-in-fact fees to be $60,000 ($85,000 minus $25,000), 
and its taxable income from its real estate management to be $15,000 
($18,000 minus $3,000). Since F's rental operations resulted in a 
$10,000 loss for the taxable year ($25,000 minus $35,000), F's taxable 
income from its rental operations is zero. Using the 30 percent rate 
provided by section 11(b), F computes its normal tax to be $18,000 on 
its attorney-in-fact fees and $4,500 on its real estate management 
operations. F's normal tax on total income is $19,500. The $3,000 
difference between the normal tax on F's total income and the normal 
taxes on F's profitable operations results from the loss on F's rental 
operations. Under paragraph (b)(3) of Sec. 1.826-5, F allocates its 
surtax exemption as follows: $20,000 ($60,000/$75,000 x $25,000) to its 
attorney-in-fact fees; and $5,000 ($15,000/$75,000 x $25,000) to its 
real estate management operations. F computes its surtax on its 
profitable operations at the 22 percent rate provided by section 11(c) 
as follows: $8,800 (22 percent of $40,000) on attorney-in-fact fees; and 
$2,200 (22 percent of $10,000) on real estate management income. F adds 
its normal tax and surtax on its profitable operations and determines 
its total tax to be $26,800 on its attorney-in-fact operations; $6,700 
on its real estate management operations; and $28,300 on its total 
income. F must allocate its investment credit on the same basis as it 
used to allocate its expenses. Thus, F's entire investment credit must 
be allocated to its attorney-in-fact operations. Accordingly, F's 1963 
tax liability is $26,000 on its attorney-in-fact fees; $6,700 on its 
real estate management operations; $0 on its rental operations; and 
$27,500 on its total income. Under paragraph (b)(7) of Sec. 1.826-5, F 
allocates $21,863 ($26,000/$32,700 x $27,500) of its 1963 tax paid to 
its attorney-in-fact fees; and $5,637 ($6,700/$32,700 x $27,500) of its 
1963 tax paid to its real estate management business. F's reciprocal 
will be allowed a credit or refund of $21,863 for taxes paid by F which 
are attributable to F's income received from its reciprocal. se *COM
    Example 3. Assume the same facts as in example 2, and assume further 
that in 1966 F sustains a net operating loss on its overall operations 
of $5,000. In carrying the loss back to 1963 as a net operating loss 
deduction under section 172, F must allocate the deduction under the 
same method it used in allocating its 1963 deductions. Thus, if the loss 
was entirely attributable to F's rental operations for the taxable year 
1966, F would reduce its taxable income attributable to those operations 
by the entire amount of the loss and would recompute the tax 
attributable to those operations under paragraph (b) of Sec. 1.826-5. As 
recomputed in the table below, F's 1963 tax liability from attorney-in-
fact fees would be $19,800 and F's total tax liability would be $24,900.

----------------------------------------------------------------------------------------------------------------
                                                                     Attorney-     Real                         
                                                                      in-fact     estate      Rental     Total  
                                                                        fees    management    income            
----------------------------------------------------------------------------------------------------------------
Gross income.......................................................    $85,000     $18,000    $25,000   $128,000
Allocable expenses.................................................     25,000       3,000     35,000     63,000
Net operating loss deduction.......................................          0           0      5,000      5,000
Taxable income (loss)..............................................     60,000      15,000   (15,000)     60,000
Normal tax (30 percent)............................................     18,000       4,500          0     18,000
Surtax exemption...................................................     20,000       5,000          0     25,000
Income subject to surtax...........................................     40,000      10,000          0     35,000
Surtax (22 percent)................................................      8,800       2,200          0      7,700
Total tax..........................................................     26,800       6,700          0     25,700
Investment credit..................................................        800           0          0        800
1963 tax liability.................................................     26,000       6,700          0     24,900
1963 tax paid......................................................  .........  ..........  .........     24,900
Allocation of tax paid.............................................     19,800       5,100          0     24,900
----------------------------------------------------------------------------------------------------------------

As a result of its 1966 net operating loss, F would be entitled to a 
refund of $2,600 (1963 taxes paid of $27,500 minus recomputed 1963 taxes 
of $24,900). Under paragraph (a) of Sec. 1.826-6, F would be required to 
notify its reciprocal of its claim for refund and of the amount of the 
refund or credit attributable to taxes paid on income received from the 
reciprocal. Since the 1963 tax paid by F attributable to its reciprocal 
(as recomputed) is less than the amount claimed in 1963 by F's 
reciprocal as a credit, F's reciprocal would be required, under section 
826(g), to add the difference--$2,063 ($21,863 minus $19,800), to its 
tax liability for 1966. Thus, F's reciprocal would first compute its tax 
liability for 1966 without regard to section 826(g) and then would 
increase such liability by $2,063.

[T.D. 6681, 28 FR 11126, Oct. 17, 1963]

[[Page 639]]

                        Other Insurance Companies



Sec. 1.831-1   Tax on insurance companies (other than life or mutual), mutual marine insurance companies, and mutual fire insurance companies issuing perpetual 
          policies.

    (a) All insurance companies, other than life or mutual or foreign 
insurance companies not carrying on an insurance business within the 
United States, and all mutual marine insurance companies and mutual fire 
insurance companies exclusively issuing either perpetual policies, or 
policies for which the sole premium charged is a single deposit which, 
except for such deduction of underwriting costs as may be provided, is 
refundable upon cancellation or expiration of the policy, are subject to 
the tax imposed by section 831. As used in this section and Secs. 1.832-
1 and 1.832-2, the term ``insurance companies'' means only those 
companies which qualify as insurance companies under the definition 
provided by paragraph (b) of Sec. 1.801-1 and which are subject to the 
tax imposed by section 831.
    (b) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 831 are 
applicable to the assessment and collection of the tax imposed by 
section 831(a), and insurance companies are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations.
    (c) Since section 832 provides that the underwriting and investment 
exhibit of the annual statement approved by the National Convention of 
Insurance Commissioners shall be the basis for computing gross income 
and since the annual statement is rendered on the calendar year basis, 
the returns under section 831 shall be made on the basis of the calendar 
year and shall be on Form 1120. Insurance companies are entitled, in 
computing insurance company taxable income, to the deductions provided 
in part VIII (section 241 and following), subchapter B, chapter 1 of the 
Code.
    (d) Foreign insurance companies not carrying on an insurance 
business within the United States are not taxable under section 831 but 
are taxable as other foreign corporations. See section 881.
    (e) Insurance companies are subject to both normal tax and surtax. 
The normal tax shall be computed as provided in section 11(b) and the 
surtax shall be computed as provided in section 11(c). For the 
circumstances under which the $25,000 exemption from surtax for certain 
taxable years may be disallowed in whole or in part, see section 1551. 
For alternative tax where the net long-term capital gain for any taxable 
year exceeds the net short-term capital loss, see section 1201(a) and 
the regulations thereunder.



Sec. 1.831-2   Taxable years affected.

    Section 1.831-1 is applicable only to taxable years beginning after 
December 31, 1953, but before January 1, 1963, and ending after August 
16, 1954, and all references therein to sections of the Code and 
regulations are to sections of the Internal Revenue Code of 1954 and the 
regulations thereunder before amendments. Section 1.831-3 is applicable 
only to taxable years beginning after December 31, 1962, and all 
references therein to sections of the Code and regulations are to 
sections of the Internal Revenue Code of 1954 as amended. Section 1.831-
4 is applicable only with respect to the companies described therein, 
and only with respect to taxable years beginning after December 31, 
1961.

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]




Sec. 1.831-3   Tax on insurance companies (other than life or mutual), mutual marine insurance companies, mutual fire insurance companies issuing perpetual 
          policies, and mutual fire or flood insurance companies 
          operating on the basis of premium deposits; taxable years 
          beginning after December 31, 1962.

    (a) All insurance companies, other than life or mutual or foreign 
insurance companies not carrying on an insurance business within the 
United States, and all mutual marine insurance companies and mutual fire 
or flood insurance companies exclusively issuing perpetual policies or 
whose principal business is the issuance of policies for which the 
premium deposits are the same regardless of the

[[Page 640]]

length of the term for which the policies are written, are subject to 
the tax imposed by section 831 if the unabsorbed portion of such premium 
deposits not required for losses, expenses or reserves is returned or 
credited to the policyholder on cancellation or expiration of the 
policy. For purposes of section 831 and this section, in the case of a 
mutual flood insurance company, the premium deposits will be considered 
to be the same if the payment of a premium increases the total insurance 
under the policy in an amount equal to the amount of such premium and 
the omission of any annual premium does not result in the reduction or 
suspension of coverage under the policy. As used in this section and 
section 832 and the regulations thereunder, the term ``insurance 
companies'' means only those companies which qualify as insurance 
companies under the definition provided by paragraph (b) of Sec. 1.801-1 
and which are subject to the tax imposed by section 831.
    (b) All provisions of the Code and of the regulations in this part 
not inconsistent with the specific provisions of section 831 are 
applicable to the assessment and collection of the tax imposed by 
section 831(a), and insurance companies are subject to the same 
penalties as are provided in the case of returns and payment of income 
tax by other corporations.
    (c) Since section 832 provides that the underwriting and investment 
exhibit of the annual statement approved by the National Convention of 
Insurance Commissioners shall be the basis for computing gross income 
and since the annual statement is rendered on the calendar year basis, 
the returns under section 831 shall be made on the basis of the calendar 
year and shall be on Form 1120. Insurance companies are entitled, in 
computing insurance company taxable income, to the deductions provided 
in part VIII (section 241 and following), subchapter B, chapter 1 of the 
Code.
    (d) Foreign insurance companies not carrying on an insurance 
business within the United States are not taxable under section 831 but 
are taxable as other foreign corporations. See section 881.
    (e) Insurance companies are subject to both normal tax and surtax. 
The normal tax shall be computed as provided in section 11(b) and the 
surtax shall be computed as provided in section 11(c). For the 
circumstances under which the $25,000 exemption from surtax for certain 
taxable years may be disallowed in whole or in part, see section 1551. 
For alternative tax where the net long-term capital gain for any taxable 
year exceeds the net short-term capital loss, see section 1201(a) and 
the regulations thereunder.

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]



Sec. 1.831-4   Election of multiple line companies to be taxed on total income.

    (a) In general. Section 831(c) provides that any mutual insurance 
company engaged in writing marine, fire, and casualty insurance which, 
for any 5-year period beginning after December 31, 1941, and ending 
before January 1, 1962, was subject to the tax imposed by section 831 
(or the tax imposed by corresponding provisions of prior law) may elect, 
in the manner provided by paragraph (b) of this section, to be subject 
to the tax imposed by section 831, whether or not marine insurance is 
its predominant source of premium income. A company making an election 
under section 831(c) and this section will be subject to the tax imposed 
by section 831 for taxable years beginning after December 31, 1961, 
rather than subject to the tax imposed by section 821.
    (b) Time and manner of making election. The election provided by 
section 831(c) and paragraph (a) of this section shall be made in a 
statement attached to the taxpayer's return for the taxable year 1962. 
The statement shall indicate that the taxpayer has made the election 
provided by section 831(c) and this section; shall include the name and 
address of the taxpayer, and shall be signed by the taxpayer or his duly 
authorized representative. In addition, the statement shall list the 5 
consecutive taxable years prior to 1962 for which the taxpayer was 
subject to tax under section 831 (or the corresponding provisions of 
prior law); the types of insurance written by the company; and the 
percentage of marine insurance to total insurance written. The return

[[Page 641]]

and statement must be filed not later than the date prescribed by law 
(including extensions thereof) for filing the return for the taxable 
year 1962. However, if the last date prescribed by law (including 
extensions thereof) for filing the income tax return for the taxable 
year 1962 falls before October 17, 1963, the election provided by 
section 831(c) and this section may be made for such year by filing the 
statement and an amended return for such taxable year (and all 
subsequent taxable years for which returns have been filed) before 
January 16, 1964.
    (c) Scope of election. An election made under section 831(c) and 
paragraph (b) of this section shall be binding for all taxable years 
beginning after December 31, 1961, unless consent to revoke the election 
is obtained from the Commissioner. However, if a taxpayer made the 
election provided by section 831(c) and this section for taxable years 
beginning prior to October 17, 1963, the taxpayer may revoke such 
election without obtaining consent from the Commissioner by filing, 
before January 16, 1964, a statement that the taxpayer desires to revoke 
such election. Such statement shall be signed by the taxpayer or its 
duly authorized representative. An amended return reflecting such 
revocation must accompany the statement for all taxable years for which 
returns have been filed with respect to such election.
    (d) Limitation on certain net operating loss carryovers and 
carrybacks. In the case of a taxpayer making the election allowed under 
section 831(c) and this section, a net operating loss shall not be 
carried:
    (1) To or from any taxable year for which the insurance company is 
not subject to the tax imposed by section 831(a) (or predecessor 
sections); or
    (2) To any taxable year if, between the loss year and such taxable 
year, there is an intervening taxable year for which the insurance 
company was not subject to the tax imposed by section 831(a) (or 
predecessor sections).

[T.D. 6681, 28 FR 11128, Oct. 17, 1963]



Sec. 1.832-1   Gross income.

    (a) Gross income as defined in section 832(b)(1) means the gross 
amount of income earned during the taxable year from interest, 
dividends, rents, and premium income, computed on the basis of the 
underwriting and investment exhibit of the annual statement approved by 
the National Convention of Insurance Commissioners, as well as the gain 
derived from the sale or other disposition of property, and all other 
items constituting gross income under section 61, except that in the 
case of a mutual fire insurance company described in Sec. 1.831-1 the 
amount of single deposit premiums received, but not assessments, shall 
be excluded from gross income. Gross income does not include increase in 
liabilities during the year on account of reinsurance treaties, 
remittances from the home office of a foreign insurance company to the 
United States branch, borrowed money, or gross increase due to 
adjustments in book value of capital assets. The underwriting and 
investment exhibit is presumed to reflect the true net income of the 
company, and insofar as it is not inconsistent with the provisions of 
the Code will be recognized and used as a basis for that purpose. All 
items of the exhibit, however, do not reflect an insurance company's 
income as defined in the Code. By reason of the definition of investment 
income, miscellaneous items which are intended to reflect surplus but do 
not properly enter into the computation of income, such as dividends 
declared to shareholders in their capacity as such, home office 
remittances and receipts, and special deposits, are ignored. Gain or 
loss from agency balances and bills receivable not admitted as assets on 
the underwriting and investment exhibit will be ignored, excepting only 
such agency balances and bills receivable as have been allowed as 
deductions for worthless debts or, having been previously so allowed, 
are recovered during the taxable year. In computing ``premiums earned on 
insurance contracts during the taxable year'' the amount of the unearned 
premiums shall include (1) life insurance reserves as defined in section 
803(b) and Sec. 1.803-1 pertaining to the life, burial, or funeral 
insurance, or annuity business of an insurance company subject to the 
tax imposed by section 831 and not qualifying as a life insurance 
company under section 801, and (2) liability for return premiums

[[Page 642]]

under a rate credit or retrospective rating plan based on experience, 
such as the ``War Department Insurance Rating Plan,'' and which return 
premiums are therefore not earned premiums. In computing ``losses 
incurred'' the determination of unpaid losses at the close of each year 
must represent actual unpaid losses as nearly as it is possible to 
ascertain them.
    (b) Every insurance company to which this section applies must be 
prepared to establish to the satisfaction of the district director that 
the part of the deduction for ``losses incurred'' which represents 
unpaid losses at the close of the taxable year comprises only actual 
unpaid losses stated in amounts which, based upon the facts in each case 
and the company's experience with similar cases, can be said to 
represent a fair and reasonable estimate of the amount the company will 
be required to pay. Amounts included in, or added to, the estimates of 
such losses which, in the opinion of the district director are in excess 
of the actual liability determined as provided in the preceding sentence 
will be disallowed as a deduction. The district director may require any 
such insurance company to submit such detailed information with respect 
to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred.''
    (c) That part of the deduction for ``losses incurred'' which 
represents an adjustment to losses paid for salvage and reinsurance 
recoverable shall, except as hereinafter provided, include all salvage 
in course of liquidation, and all reinsurance in process of collection 
not otherwise taken into account as a reduction of losses paid, 
outstanding at the end of the taxable year. Salvage in course of 
liquidation includes all property (other than cash), real or personal, 
tangible or intangible, except that which may not be included by reason 
of express statutory provisions (or rules and regulations of an 
insurance department) of any State or Territory or the District of 
Columbia in which the company transacts business. Such salvage in course 
of liquidation shall be taken into account to the extent of the value 
thereof at the end of the taxable year as determined from a fair and 
reasonable estimate based upon either the facts in each case or the 
company's experience with similar cases. Cash received during the 
taxable year with respect to items of salvage or reinsurance shall be 
taken into account in computing losses paid during such taxable year.



Sec. 1.832-2   Deductions.

    (a) The deductions allowable are specified in section 832(c) and by 
reason of the provisions of section 832(c)(10) and (12) include in 
addition certain deductions provided in sections 161, and 241 and 
following. The deductions, however, are subject to the limitation 
provided in section 265, relating to expenses and interest in respect of 
tax-exempt income. The net operating loss deduction is computed under 
section 172 and the regulations thereunder. For the purposes of section 
172, relating to net operating loss deduction, ``gross income'' shall 
mean gross income as defined in section 832(b)(1) and the allowable 
deductions shall be those allowed by section 832(c) with the exceptions 
and limitations set forth in section 172(d). In addition to the 
deduction for capital losses provided in subchapter P (section 1201 and 
following), chapter 1 of the Code, insurance companies are allowed a 
deduction for losses from capital assets sold or exchanged in order to 
obtain funds to meet abnormal insurance losses and to provide for the 
payment of dividends and similar distributions to policyholders. A 
special rule is provided for the application of the capital loss 
carryover provisions of section 1212. The deduction is the same as that 
allowed mutual insurance companies subject to the tax imposed by section 
821; see section 822(c)(6) and the regulations thereunder. Insurance 
companies, other than mutual fire insurance companies described in 
Sec. 1.831-1, are also allowed a deduction for dividends and similar 
distributions paid or declared to policyholders in their capacity as 
such. The deduction is otherwise the same as that allowed mutual 
insurance companies subject to the tax imposed by section 821; see 
section 823(2) and the regulations thereunder.
    (b) Among the items which may not be deducted are income and profits

[[Page 643]]

taxes imposed by the United States, income and profits taxes imposed by 
any foreign country or possession of the United States (in cases where 
the company chooses to claim to any extent a credit for such taxes), 
taxes assessed against local benefits, decrease during the year due to 
adjustments in the book value of capital assets, decrease in liabilities 
during the year on account of reinsurance treaties, dividends paid to 
shareholders in their capacity as such, remittances to the home office 
of a foreign insurance company by the United States branch, and borrowed 
money repaid.
    (c) In computing taxable income of insurance companies, losses 
sustained during the taxable year from the sale or other disposition of 
property are deductible subject to the limitation contained in section 
1211. Insurance companies are entitled to the alternative taxes provided 
in section 1201.

[T.D. 6500, 25 FR 11814, Nov. 26, 1960, as amended by T.D. 6867, 30 FR 
15094, Dec. 12, 1965]



Sec. 1.832-3   Taxable years affected.

    Sections 1.832-1 and 1.832-2 are applicable only to taxable years 
beginning after December 31, 1953, and before January 1, 1963, and 
ending after August 16, 1954, and all references therein to sections of 
the Code and regulations are to sections of the Internal Revenue Code of 
1954 and the regulations thereunder before amendments. Sections 1.832-4, 
1.832-5, and 1.832-6 are applicable only to taxable years beginning 
after December 31, 1962, and all references therein to sections of the 
Code and regulations are to sections of the Internal Revenue Code of 
1954 as amended.

[T.D. 6681, 28 FR 11129, Oct. 17, 1963]



Sec. 1.832-4   Gross income.

    (a)(1) Gross income as defined in section 832(b)(1) means the gross 
amount of income earned during the taxable year from interest, 
dividends, rents, and premium income, computed on the basis of the 
underwriting and investment exhibit of the annual statement approved by 
the National Convention of Insurance Commissioners, as well as the gain 
derived from the sale or other disposition of property, and all other 
items constituting gross income under section 61, except that in the 
case of a mutual fire insurance company described in section 
831(a)(3)(A) the amount of single deposit premiums received, but not 
assessments, shall be excluded from gross income. Section 832(b)(1)(D) 
provides that in the case of a mutual fire or flood insurance company 
described in section 831(a)(3)(B), there shall be included in gross 
income an amount equal to 2 percent of the premiums earned during the 
taxable year on contracts described in section 831(a)(3)(B) after 
deduction of premium deposits returned or credited during such taxable 
year with respect to such contracts. Gross income does not include 
increase in liabilities during the year on account of reinsurance 
treaties, remittances from the home office of a foreign insurance 
company to the United States branch, borrowed money, or gross increase 
due to adjustments in book value of capital assets.
    (2) The underwriting and investment exhibit is presumed to reflect 
the true net income of the company, and insofar as it is not 
inconsistent with the provisions of the Code will be recognized and used 
as a basis for that purpose. All items of the exhibit, however, do not 
reflect an insurance company's income as defined in the Code. By reason 
of the definition of investment income, miscellaneous items which are 
intended to reflect surplus but do not properly enter into the 
computation of income, such as dividends declared to shareholders in 
their capacity as such, home office remittances and receipts, and 
special deposits, are ignored. Gain or loss from agency balances and 
bills receivable not admitted as assets on the underwriting and 
investment exhibit will be ignored, excepting only such agency balances 
and bills receivable as have been allowed as deductions for worthless 
debts or, having been previously so allowed, are recovered during the 
taxable year.
    (3) In computing ``premiums earned on insurance contracts during the 
taxable year'' the amount of the unearned premiums shall include:
    (i) Life insurance reserves as defined in section 803(b) and 
Sec. 1.803-1 pertaining to the life, burial, or funeral insurance,

[[Page 644]]

or annuity business of an insurance company subject to the tax imposed 
by section 831 and not qualifying as a life insurance company under 
section 801;
    (ii) Liability for return premiums under a rate credit or 
retrospective rating plan based on experience, such as the ``War 
Department Insurance Rating Plan,'' and which return premiums are 
therefore not earned premiums; and
    (iii) In the case of a mutual fire or flood insurance company 
described in section 831(a)(3)(B) (with respect to the contracts 
described therein), the amount of unabsorbed premium deposits which the 
company would be obligated to return to its policyholders at the close 
of the company's taxable year if all of its policies were terminated at 
such time.
    (4) In computing the amount of unabsorbed premium deposits which a 
mutual fire or flood insurance company described in section 831(a)(3)(B) 
would be obligated to return to its policyholders at the close of its 
taxable year, the company must use its own schedule of unabsorbed 
premium deposit returns then in effect. A copy of the applicable 
schedule must be filed with the company's income tax return for each 
taxable year for which a computation based upon such schedule is made. 
In addition, a taxpayer making such a computation must provide the 
following information for each taxable year for which the computation is 
made:
    (i) The amount of gross premiums received during the taxable year, 
and the amount of premiums paid for reinsurance during the taxable year, 
on the policies described in section 831(a)(3)(B) and on other policies;
    (ii) The amount of insurance written during the taxable year under 
the policies described in section 831(a)(3)(B) and under other policies, 
and the amount of such insurance written which was reinsured during the 
taxable year. The information required under this subdivision shall only 
be submitted upon the specific request of the district director for a 
statement setting forth such information, and, if required, such 
statement shall be filed in the manner provided by this subparagraph or 
in such other manner as is satisfactory to the district director;
    (iii) The amount of premiums earned during the taxable year on the 
policies described in section 831(a)(3)(B) and on other policies and the 
computations by which such amounts were determined, including sufficient 
information to support the taxpayer's determination of the amount of 
unearned premiums on premium deposit plan and other policies at the 
beginning and end of the taxable year, and the amount of unabsorbed 
premium deposits at the beginning and end of the taxable year on 
policies described in section 831(a)(3)(B).

The information required by this subparagraph shall be set forth in a 
statement attached to the taxpayer's income tax return for the taxable 
year for which such information is being provided. Such statement shall 
include the name and address of the taxpayer, and shall be filed not 
later than the date prescribed by law (including extensions thereof) for 
filing the income tax return for the taxable year.
    (5) In computing ``losses incurred'' the determination of unpaid 
losses at the close of each year must represent actual unpaid losses as 
nearly as it is possible to ascertain them.
    (b) Losses incurred. Every insurance company to which this section 
applies must be prepared to establish to the satisfaction of the 
district director that the part of the deduction for ``losses incurred'' 
which represents unpaid losses at the close of the taxable year 
comprises only actual unpaid losses. See section 846 for rules relating 
to the determination of discounted unpaid losses. These losses must be 
stated in amounts which, based upon the facts in each case and the 
company's experience with similar cases, represent a fair and reasonable 
estimate of the amount the company will be required to pay. Amounts 
included in, or added to, the estimates of unpaid losses which, in the 
opinion of the district director, are in excess of a fair and reasonable 
estimate will be disallowed as a deduction. The district director may 
require any insurance company to submit such detailed information with 
respect to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred.''

[[Page 645]]

    (c) Losses incurred are reduced by salvage. Under section 
832(b)(5)(A), losses incurred are computed by taking into account losses 
paid reduced by salvage and reinsurance recovered, the change in 
discounted unpaid losses, and the change in estimated salvage and 
reinsurance recoverable. For purposes of section 832(b)(5)(A)(iii), 
estimated salvage recoverable includes all anticipated recoveries on 
account of salvage, whether or not the salvage is treated, or may be 
treated, as an asset for state statutory accounting purposes. Estimates 
of salvage recoverable must be based on the facts of each case and the 
company's experience with similar cases. Except as otherwise provided in 
guidance published by the Commissioner in the Internal Revenue Bulletin, 
estimated salvage recoverable must be discounted either--
    (1) By using the applicable discount factors published by the 
Commissioner for estimated salvage recoverable; or
    (2) By using the loss payment pattern for a line of business as the 
salvage recovery pattern for that line of business and by using the 
applicable interest rate for calculating unpaid losses under section 
846(c). For purposes of section 832(b)(5)(A) and the regulations 
thereunder, the term ``salvage recoverable'' includes anticipated 
recoveries on account of subrogation claims arising with respect to paid 
or unpaid losses.
    (d) Increase in unpaid losses shown on annual statement in certain 
circumstances--(1) In general. An insurance company that takes estimated 
salvage recoverable into account in determining the amount of its unpaid 
losses shown on its annual statement is allowed to increase its unpaid 
losses by the amount of estimated salvage recoverable taken into account 
if the company complies with the disclosure requirement of paragraph 
(d)(2) of this section. This adjustment shall not be used in determining 
under section 846(d) the loss payment pattern for a line of business.
    (2) Disclosure requirement. (i) In general. A company described in 
paragraph (d)(1) of this section is allowed to increase the unpaid 
losses shown on its annual statement only if the company either--
    (A) Discloses on its annual statement, by line of business and 
accident year, the extent to which estimated salvage recoverable is 
taken into account in computing the unpaid losses shown on the annual 
statement filed by the company for the calendar year ending with or 
within the taxable year of the company; or
    (B) Files a statement on or before the due date of its Federal 
income tax return (determined without regard to extensions) with the 
appropriate state regulatory authority of each state to which the 
company is required to submit an annual statement. The statement must be 
contained in a separate document captioned ``DISCLOSURE CONCERNING LOSS 
RESERVES'' and must disclose, by line of business and accident year, the 
extent to which estimated salvage recoverable is taken into account in 
computing the unpaid losses shown on the annual statement filed by the 
company for the calendar year ending with or within the taxable year of 
the company.
    (ii) Transitional rule. For a taxable year ending before December 
31, 1991, a taxpayer is deemed to satisfy the disclosure requirement of 
paragraph (d)(2)(i)(B) of this section if the taxpayer files the 
statement described in paragraph (d)(2)(i)(B) of this section before 
March 17, 1992.
    (3) Failure to disclose in a subsequent year. If a company that 
claims the increase permitted by paragraph (d)(1) of this section fails 
in a subsequent taxable year to make the disclosure described in 
paragraph (d)(2) of this section, the company cannot claim an increase 
under paragraph (d)(1) of this section in any subsequent taxable year 
without the consent of the Commissioner.
    (e) Treatment of estimated salvage recoverable--(1) In general. An 
insurance company is required to take estimated salvage recoverable 
(including that which cannot be treated as an asset for state statutory 
accounting purposes) into account in computing the deduction for losses 
incurred. Except as provided in paragraph (e)(2)(iii) of this section, 
an insurance company must apply this method of accounting to estimated 
salvage recoverable for all lines of business and for all accident 
years.

[[Page 646]]

    (2) Change in method of accounting--(i) If an insurance company did 
not take estimated salvage recoverable into account as required by 
paragraph (c) of this section for its last taxable year beginning before 
January 1, 1990, taking estimated salvage recoverable into account as 
required by paragraph (c) of this section is a change in method of 
accounting.
    (ii) If a company does not claim the deduction under section 
11305(c)(3) of the 1990 Act, the company must take into account 13 
percent of the adjustment that would otherwise be required under section 
481 for pre-1990 accident years as a result of the change in accounting 
method. This paragraph (e)(2)(ii) applies only to an insurance company 
subject to tax under section 831.
    (iii) If a company claims the deduction under section 11305(c)(3) of 
the 1990 Act and paragraph (f) of this section, the company must 
implement the change in method of accounting for estimated salvage 
recoverable for post-1989 taxable years pursuant to a ``cut-off'' 
method.
    (3) Rule for overestimates. An insurance company is required under 
section 11305(c)(4) of the 1990 Act to include in gross income 87 
percent of any amount (adjusted for discounting) by which the section 
481 adjustment is overestimated. The rule is applied by comparing the 
amount of the section 481 adjustment (determined without regard to 
paragraph (e)(2)(ii) of this section and any discounting) to the sum of 
the actual salvage recoveries and remaining undiscounted estimated 
salvage recoverable that are attributable to losses incurred in accident 
years beginning before 1990. For any taxable year beginning after 
December 31, 1989, any excess of the section 481 adjustment over this 
sum (reduced by amounts treated as overestimates in prior taxable years 
pursuant to this paragraph (e)(3)) is an overestimate. To determine the 
amount to be included in income, it is necessary to discount this excess 
and multiply the resulting amount by 87 percent.
    (f) Special deduction--(1) In general. Under section 11305(c)(3) of 
the 1990 Act, an insurance company may deduct an amount equal to 87 
percent of the discounted amount of estimated salvage recoverable that 
the company took into account in determining the deduction for losses 
incurred under section 832(b)(5) in the last taxable year beginning 
before January 1, 1990. A company that claims the special deduction must 
establish to the satisfaction of the district director that the 
deduction represents only the discounted amount of estimated salvage 
recoverable that was actually taken into account by the company in 
computing losses incurred for that taxable year.
    (2) Safe harbor. The requirements of paragraph (f)(1) of this 
section are deemed satisfied and the amount that the company reports as 
bona fide estimated salvage recoverable is not subject to adjustment by 
the district director, if--
    (i) The company files with the insurance regulatory authority of the 
company's state of domicile, on or before September 16, 1991, a 
statement disclosing the extent to which losses incurred for each line 
of business reported on its 1989 annual statement were reduced by 
estimated salvage recoverable,
    (ii) The company attaches a statement to its Federal income tax 
return filed for the first taxable year beginning after December 31, 
1989, agreeing to apply the special rule for overestimates under section 
11305(c)(4) of the 1990 Act to the amount of estimated salvage 
recoverable for which it has taken the special deduction, and
    (iii) In the case of a company that is a member of a consolidated 
group, each insurance company subject to tax under section 831 that is 
included in the consolidated group complies with paragraph (f)(2)(ii) of 
this section with respect to its special deduction, if any.
    (3) Limitations on special deduction--(i) The special deduction 
under section 11305(c)(3) of the 1990 Act is available only to an 
insurance company subject to tax under section 831.
    (ii) An insurance company that claimed the benefit of the ``fresh 
start'' with respect to estimated salvage recoverable under section 
1023(e) of the Tax Reform Act of 1986 may not claim the special 
deduction allowed by section 11305(c)(3) of the 1990 Act to the

[[Page 647]]

extent of the estimated salvage recoverable for which a fresh start 
benefit was previously claimed.
    (iii) A company that claims the special deduction is precluded from 
also claiming the section 481 adjustment provided in paragraph 
(e)(2)(ii) of this section for pre-1990 accident years.
    (g) Effective date. Paragraphs (b) through (f) of this section are 
effective for taxable years beginning after December 31, 1989.

[T.D. 6681, 28 FR 11129, Oct. 17, 1963, as amended by T.D. 8171, 53 FR 
118, Jan. 5, 1988; T.D. 8293, 55 FR 9425, Mar. 14, 1990. Redesignated 
and amended by T.D. 8390, 57 FR 3132, Jan. 28, 1992; 57 FR 6353, Feb. 
24, 1992]



Sec. 1.832-5   Deductions.

    (a) The deductions allowable are specified in section 832(c) and by 
reason of the provisions of section 832(c)(10) and (12) include in 
addition certain deductions provided in sections 161, and 241 and 
following. The deductions, however, are subject to the limitation 
provided in section 265, relating to expenses and interest in respect of 
tax-exempt income. The net operating loss deduction is computed under 
section 172 and the regulations thereunder. For the purposes of section 
172, relating to net operating loss deduction, ``gross income'' shall 
mean gross income as defined in section 832(b)(1) and the allowable 
deductions shall be those allowed by section 832(c) with the exceptions 
and limitations set forth in section 172(d). In addition to the 
deduction for capital losses provided in subchapter P (section 1201 and 
following), chapter 1 of the Code, insurance companies are allowed a 
deduction for losses from capital assets sold or exchanged in order to 
obtain funds to meet abnormal insurance losses and to provide for the 
payment of dividends and similar distributions to policyholders. A 
special rule is provided for the application of the capital loss 
carryover provisions of section 1212. The deduction is the same as that 
allowed mutual insurance companies subject to the tax imposed by section 
821; see section 822(c)(6) and the regulation thereunder. Insurance 
companies, other than mutual fire insurance companies described in 
section 831(a)(3)(A) and the regulations thereunder, are also allowed a 
deduction for dividends and similar distributions paid or declared to 
policyholders in their capacity as such. Similar distributions include 
such payments as the so-called unabsorbed premium deposits returned to 
policyholders by factory mutual insurance companies. The deduction is 
otherwise the same as that allowed mutual insurance companies subject to 
the tax imposed by section 821; see section 822(f)(2) and the 
regulations thereunder.
    (b) Among the items which may not be deducted are income and profits 
taxes imposed by the United States, income and profits taxes imposed by 
any foreign country or possession of the United States (in cases where 
the company chooses to claim to any extent a credit for such taxes), 
taxes assessed against local benefits, decrease during the year due to 
adjustments in the book value of capital assets, decrease in liabilities 
during the year on account of reinsurance treaties, dividends paid to 
shareholders in their capacity as such, remittances to the home office 
of a foreign insurance company by the United States branch, and borrowed 
money repaid.
    (c) In computing taxable income of insurance companies, losses 
sustained during the taxable year from the sale or other disposition of 
property are deductible subject to the limitation contained in section 
1211. Insurance companies are entitled to the alternative taxes provided 
in section 1201.

[T.D. 6681, 28 FR 11130, Oct. 17, 1963, as amended by T.D. 6867, 30 FR 
15094, Dec. 7, 1965]



Sec. 1.832-6   Policyholders of mutual fire or flood insurance companies operating on the basis of premium deposits.

    For purposes of determining his taxable income for any taxable year, 
a taxpayer insured by a mutual fire or flood insurance company under a 
policy for which the premium deposit is the same regardless of the 
length of the term for which the policy is written, and who is entitled 
to have returned or credited to his on the cancellation or expiration of 
such policy the unabsorbed portion of the premium deposit not required 
for losses, expenses, or establishment of reserves, may, if

[[Page 648]]

such amount is otherwise deductible under this chapter, deduct so much 
of his premium deposit as was absorbed by the company during the 
taxpayer's taxable year. The amount of the premium deposit absorbed 
during the taxpayer's taxable year shall be determined in accordance 
with the schedule of unabsorbed premium deposit returns in effect for 
the company during such taxable year. If the taxpayer is unable to 
determine the applicable rate of absorption in effect during his taxable 
year, he shall compute his deduction on the basis of the rate of 
absorption in effect at the end of the company's taxable year which next 
preceded the end of the taxpayer's taxable year. In such a case, an 
appropriate adjustment will be made upon the final determination of the 
rate of absorption applicable to the taxable year.

[T.D. 6681, 28 FR 11130, Oct. 17, 1963]



Sec. 1.832-7T  Treatment of salvage and reinsurance in computing ``losses incurred'' deduction, taxable years beginning before January 1, 1990 (temporary).

    (a) In computing ``losses incurred'' the determination of unpaid 
losses at the close of each year must represent actual unpaid losses as 
nearly as it is possible to ascertain them.
    (b) Every insurance company to which this section applies must be 
prepared to establish to the satisfaction of the district director that 
the part of the deduction for ``losses incurred'' which represents 
unpaid losses at the close of the taxable year comprises only actual 
unpaid losses stated in amounts which, based upon the facts in each case 
and the company's experience with similar cases, can be said to 
represent a fair and reasonable estimate of the amount the company will 
be required to pay. Amounts included in, or added to, the estimates of 
such losses which in the opinion of the district director are in excess 
of the actual liability determined as provided in the preceding sentence 
will be disallowed as a deduction. The district director may require any 
such insurance company to submit such detailed information with respect 
to its actual experience as is deemed necessary to establish the 
reasonableness of the deduction for ``losses incurred''.
    (c) That part of the deduction for ``losses incurred'' which 
represents an adjustment to losses paid for salvage and reinsurance 
recoverable shall, except as hereinafter provided, include all salvage 
in course of liquidation, and all reinsurance in process of collection 
not otherwise taken into account as a reduction of losses paid, 
outstanding at the end of the taxable year. Salvage in course of 
liquidation includes all property (other than cash), real or personal, 
tangible or intangible, except that which may not be included by reason 
of express statutory provisions (or rules and regulations of an 
insurance department) of any State or Territory or the District of 
Columbia in which the company transacts business. Such salvage in course 
of liquidation shall be taken into account to the extent of the value 
thereof at the end of the taxable year as determined from a fair and 
reasonable estimate based upon either the facts in each case or the 
company's experience with similar cases. Cash received during the 
taxable year with respect to items of salvage or reinsurance shall be 
taken into account in computing losses paid during such taxable year.
    (d) This section is effective for taxable years beginning before 
January 1, 1990.

[T.D. 8266, 54 FR 38970, Sept. 22, 1989; T.D. 8293, 55 FR 9425, Mar. 14, 
1990]



Sec. 1.846-0  Outline of provisions.

    The following is a list of the headings in Secs. 1.846-1 through 
1.846-4.

              Sec. 1.846-1 Application of discount factors.

    (a) In general.
    (1) Rules.
    (2) Examples.
    (3) Increase in discounted unpaid losses shown on the annual 
statement.
    (4) Increase in unpaid losses which take into account estimated 
salvage recoverable.
    (b) Applicable discount factors.
    (1) In general.
    (i) Discount factors published by the Service.
    (ii) Composite discount factors.
    (iii) Annual statement changes.
    (2) Title insurance company reserves.
    (3) Reinsurance business.
    (i) Proportional reinsurance for accident years after 1987.

[[Page 649]]

    (ii) Non-proportional reinsurance.
    (A) Accident years after 1991.
    (B) Accident years 1988 through 1991.
    (iii) Reinsurance for accident years before 1988.
    (iv) 90 percent exception.
    (4) International business.
    (5) Composite discount factors.

Sec. 1.846-2 Election by taxpayer to use its own historical loss payment 
                                pattern.

    (a) In general.
    (b) Eligible line of business.
    (1) In general.
    (2) Other published guidance.
    (3) Special rule for 1987 determination year.
    (c) Anti-abuse rule.

           Sec. 1.846-3 Fresh start and reserve strengthening.

    (a) In general.
    (b) Applicable discount factors.
    (1) Calculation of beginning balance.
    (2) Example.
    (c) Rules for determining the amount of reserve strengthening.
    (1) In general.
    (2) Accident years after 1985.
    (i) In general.
    (ii) Hypothetical unpaid loss reserve.
    (3) Accident years before 1986.
    (i) In general.
    (ii) Exceptions.
    (iii) Certain transactions deemed to be reinsurance assumed (ceded) 
in 1986.
    (d) Section 845.
    (e) Treatment of reserve strengthening.
    (f) Examples.

                      Sec. 1.846-4 Effective date.

[T.D. 8433, 57 FR 40843, Sept. 8, 1992; 57 FR 48563, Oct. 27, 1992]



Sec. 1.846-1  Application of discount factors.

    (a) In general--(1) Rules. A separate series of discount factors are 
computed for, and applied, to undiscounted unpaid losses attributable to 
each accident year of each line of business shown on the annual 
statement (as defined by section 846(f)(3)) filed by that taxpayer for 
the calendar year ending with or within the taxable year of the 
taxpayer. See Sec. 1.832-4(b) relating to the determination of unpaid 
losses. Paragraph (b) of this section provides rules relating to 
applicable discount factors and Sec. 1.846-3(b) contains guidance 
relating to discount factors applicable to accident years prior to the 
1987 accident year. Once a taxpayer applies a series of discount factors 
to unpaid losses attributable to an accident year of a line of business, 
that series of discount factors must be applied to discount the unpaid 
losses for that accident year for that line of business for all future 
taxable years. The discount factors cannot be changed to reflect a 
change in the taxpayer's loss payment pattern during a subsequent year 
or to reflect a different interest rate assumption. However, discount 
factors may be changed for taxpayers who elect to use their own 
historical loss payment pattern, if information upon which the pattern 
is based is adjusted upon examination by the district director.
    (2) Examples. The following examples illustrate the principles of 
paragraph (a)(1) of this section:

    Example 1. A taxpayer discounts unpaid losses attributable to all 
accident years prior to 1992 using discount factors published by the 
Service. In 1992, the taxpayer elects, under Sec. 1.846-2, to compute 
discount factors using its own historical loss payment pattern. The 
taxpayer must continue to discount unpaid losses attributable to pre-
1992 accident years using the discount factors published for those 
accident years by the Service.
    Example 2. On its annual statements through 1987, a taxpayer did not 
allocate unpaid losses attributable to proportional reinsurance to the 
line of business associated with the risks being reinsured. Beginning 
with the 1988 annual statement, the taxpayer allocated those losses for 
all accident years to the line of business being reinsured. The taxpayer 
must continue to discount the unpaid losses attributable to proportional 
reinsurance from pre-1988 accident years using the discount factors that 
were used in determining tax reserves for the 1987 tax year. (See 
paragraph (b)(3) of this section for rules relating to the application 
of discount factors to reinsurance unpaid losses.)

    (3) Increase in discounted unpaid losses shown on the annual 
statement. If the amount of unpaid losses shown on the annual statement 
is determined on a discounted basis, and the extent to which the unpaid 
losses were discounted can be determined on the basis of information 
disclosed on or with the annual statement, the amount of the unpaid 
losses to which the discount factors are applied shall be determined 
without regard to any reduction attributable to the discounting 
reflected on the annual statement.

[[Page 650]]

    (4) Increase in unpaid losses which take into account estimated 
salvage recoverable. If the amount of unpaid losses shown on the annual 
statement reflects a reduction for estimated salvage recoverable and the 
extent to which the unpaid losses were reduced by estimated salvage 
recoverable is appropriately disclosed as required by Sec. 1.832-
4(d)(2), the amount of unpaid losses shall be determined without regard 
to the reduction for salvage recoverable.
    (b) Applicable discount factors--(1) In general. Except as otherwise 
provided in section 846(f)(6) (relating to certain accident and health 
lines of business), in Sec. 1.846-2 (relating to a taxpayer's election 
to use its own historical loss payment pattern), in this paragraph (b), 
or in other guidance published in the Internal Revenue Bulletin, the 
following factors must be used--
    (i) Discount factors published by the Service. If the Service has 
published discount factors for a line of business, a taxpayer must 
discount unpaid losses attributable to that line by applying those 
discount factors; and
    (ii) Composite discount factors. If the Service has not published 
discount factors for a line of business, a taxpayer must discount unpaid 
losses attributable to that line by applying composite discount factors.
    (iii) Annual statement changes. If the groupings of individual lines 
of business on the annual statement changes, taxpayers must discount the 
unpaid losses on the resulting lines of business with the discounting 
patterns that would have applied to those unpaid losses based on their 
annual statement classification prior to the change.
    (2) Title insurance company reserves. A title insurance company may 
only take into account case reserves (relating to claims which have been 
reported to the insurance company). Unless the Service publishes other 
guidance, the reserves must be discounted using the ``Miscellaneous 
Casualty'' discount factors published by the Service. Section 832(b)(8) 
provides rules for determining the discounted unearned premiums of a 
title insurance company.
    (3) Reinsurance business--(i) Proportional reinsurance for accident 
years after 1987. For the 1988 accident year and subsequent accident 
years, unpaid losses for proportional reinsurance must be discounted 
using discount factors applicable to the line of business to which those 
unpaid losses are allocated as required on the annual statement.
    (ii) Non-proportional reinsurance--(A) Accident years after 1991. 
For the 1992 accident year and subsequent accident years, unpaid losses 
for non-proportional reinsurance must be discounted using the applicable 
discount factors published by the Service for the appropriate 
reinsurance line of business.
    (B) Accident years 1988 through 1991. For the 1988, 1989, 1990, and 
1991 accident years unpaid losses for non-proportional reinsurance must 
be discounted using composite discount factors.
    (iii) Reinsurance for accident years before 1988. If on its annual 
statement a taxpayer does not allocate unpaid losses to the applicable 
line of business for proportional or nonproportional reinsurance 
attributable to the 1987 accident year or a prior accident year, those 
losses must be discounted using composite discount factors. If on its 
annual statement a taxpayer allocates to the underlying line of business 
reinsurance unpaid losses that are attributable to the 1987 accident 
year or a prior accident year, those losses must be discounted using 
discount factors applicable to the underlying line of business.
    (iv) 90 percent exception. For purposes of Sec. 1.846-1(b)(3) (ii) 
and (iii), if more than 90 percent of all the unallocated losses of a 
taxpayer for an accident year relate to one underlying line of business, 
the taxpayer must discount all unallocable reinsurance unpaid losses 
attributable to that accident year using the discount factors published 
by the Service for the underlying line of business.
    (4) International business. For any accident year, unpaid losses 
which are attributable to international business must be discounted 
using composite discount factors unless more than 90 percent of all 
losses for that accident year relate to one underlying line of business. 
If more than 90 percent of all losses for an accident year relate to one 
underlying line of business, the

[[Page 651]]

taxpayer must discount the losses attributable to that accident year 
using discount factors published by the Service for the underlying line 
of business.
    (5) Composite discount factors. For purposes of the regulations 
under section 846, ``composite discount factors'' means the series of 
discount factors published annually by the Service determined on the 
basis of the appropriate composite loss payment pattern.

[T.D. 8433, 57 FR 40844, Sept. 8, 1992]



Sec. 1.846-2  Election by taxpayer to use its own historical loss payment pattern.

    (a) In general. If a taxpayer has one or more eligible lines of 
business in a determination year, the taxpayer may elect on the 
taxpayer's timely filed Federal income tax return for the determination 
year to discount unpaid losses using its own historical loss payment 
pattern instead of the industry-wide pattern determined by the 
Secretary. A taxpayer making the election must use its own historical 
loss payment pattern in discounting unpaid losses for each line of 
business that is an eligible line of business in that determination 
year. The election applies to accident years ending with the 
determination year and to each of the four succeeding accident years. If 
a taxpayer makes the election for the 1987 determination year, the 
taxpayer must use its 1987 loss payment pattern (determined by reference 
to its 1985 annual statement) to discount unpaid losses attributable to 
all accident years prior to 1988.
    (b) Eligible line of business--(1) In general. A line of business is 
an eligible line of business in a determination year if, on the most 
recent annual statement filed by the taxpayer before the beginning of 
that determination year, the taxpayer reports losses and loss expenses 
incurred (in Schedule P, part 1, column 24 of the 1990 annual statement 
or comparable location in an earlier or subsequently revised blank) for 
at least the number of accident years for which losses and loss expenses 
incurred for that line of business are required to be separately 
reported on that annual statement. For example, for the 1987 
determination year, the 1985 annual statement is used. The annual 
statement to be used to determine eligibility in subsequent 
determination years is the annual statement for each fifth year after 
1985 (e.g., 1990, 1995, etc.).
    (2) Other published guidance. A line of business is also an eligible 
line of business for purposes of the election if the line is an eligible 
line under requirements published for this purpose in the Internal 
Revenue Bulletin.
    (3) Special rule for 1987 determination year. A line of business is 
an eligible line of business in the 1987 determination year if it is 
eligible under paragraph (b) (1) or (2) of this section, or if on the 
most recent annual statement filed by the taxpayer before the beginning 
of the 1987 determination year, the taxpayer reports written premiums 
for the line of business for at least the number of accident years that 
unpaid losses for that line of business are required to be separately 
reported on that annual statement.
    (c) Anti-abuse rule. To prevent avoidance of the requirement that 
the election to use historical loss payment patterns apply to all 
eligible lines of business of a taxpayer, the district director may--
    (1) Nullify a taxpayer's election to compute discounted unpaid 
losses based on its historical loss payment pattern;
    (2) Adjust a taxpayer's historical loss payment pattern; or
    (3) Make other proper adjustments.

[T.D. 8433, 57 FR 40845, Sept. 8, 1992]



Sec. 1.846-3  Fresh start and reserve strengthening.

    (a) In general. Section 1023(e) of the Tax Reform Act of 1986 (``the 
1986 Act'') provides rules relating to fresh start and reserve 
strengthening. For purposes of section 1023(e) of the 1986 Act, a 
taxpayer must discount its unpaid losses as of the end of the last 
taxable year beginning before January 1, 1987. The excess of 
undiscounted unpaid losses over discounted unpaid losses as of that time 
is not required to be included in income, except (as provided in 
paragraph (e) of this section) to the extent of any ``reserve 
strengthening'' in a taxable year beginning in 1986. The exclusion from 
income of this excess is known as ``fresh start.'' The amount of

[[Page 652]]

fresh start is, however, included in earnings and profits for the first 
taxable year beginning after December 31, 1986.
    (b) Applicable discount factors--(1) Calculation of beginning 
balance. For purposes of section 1023(e) of the 1986 Act, a taxpayer 
discounts unpaid losses as of the end of the last taxable year beginning 
before January 1, 1987--
    (i) By using the same discount factors that are used in the 
succeeding taxable year to discount unpaid losses attributable to the 
1987 accident year and prior accident years (see section 1023(e)(2) of 
the 1986 Act); and
    (ii) By applying those discount factors as if the 1986 accident year 
were the 1987 accident year.
    (2) Example. The following example illustrates the principles of 
this paragraph (b):

    Example. X, a calendar year taxpayer, does not make an election in 
1987 to use its own historical loss payment pattern. When X computes 
discounted unpaid losses for its last taxable year beginning before 
January 1, 1987, the discount factor for AY+0 published in Rev. Rul. 87-
34, 1987-1 C.B. 168, must be applied to unpaid losses attributable to 
the 1986 accident year; the discount factor for AY+1 is applied to 
unpaid losses attributable to the 1985 accident year; etc.

    (c) Rules for determining the amount of reserve strengthening 
(weakening)--(1) In general. The amount of reserve strengthening 
(weakening) is the amount that is determined under paragraph (c)(2) or 
(3) to have been added to (subtracted from) an unpaid loss reserve in a 
taxable year beginning in 1986. For purposes of section 1023(e)(3)(B) of 
the 1986 Act, the amount of reserve strengthening (weakening) must be 
determined separately for each unpaid loss reserve by applying the rules 
of this paragraph (c). This determination is made without regard to the 
reasonableness of the amount of the unpaid loss reserve and without 
regard to the taxpayer's discretion, or lack thereof, in establishing 
the amount of the unpaid loss reserve. The amount of reserve 
strengthening for an unpaid loss reserve may not exceed the amount of 
the reserve, including any undiscounted strengthening amount, as of the 
end of the last taxable year beginning before January 1, 1987. For 
purposes of this section, an ``unpaid loss reserve'' is the aggregate of 
the unpaid loss estimate for losses (whether or not reported) incurred 
in an accident year of a line of business.
    (2) Accident years after 1985--(i) In general. The amount of reserve 
strengthening (weakening) for an unpaid loss reserve for an accident 
year after 1985 is the amount by which that reserve at the end of the 
last taxable year beginning in 1986 exceeds (is less than) a 
hypothetical unpaid loss reserve.
    (ii) Hypothetical unpaid loss reserve. For purposes of this 
paragraph (c)(2), the term ``hypothetical unpaid loss reserve'' means a 
reserve computed for losses the estimates of which were included, at the 
end of the last taxable year beginning in 1986, in the unpaid loss 
reserve for which reserve strengthening (weakening) is being determined. 
The hypothetical unpaid loss reserve must be computed using the same 
assumptions, other than the assumed interest rates in the case of 
reserves determined on a discounted basis for annual statement reporting 
purposes, that were used to determine the 1985 accident year reserve, if 
any, for the line of business for which the hypothetical reserve is 
being computed. If there was no 1985 accident year reserve for that line 
of business, the hypothetical unpaid loss reserve is the reserve, at the 
end of the last taxable year beginning in 1986, for which reserve 
strengthening (weakening) is being determined (and thus there is no 
reserve strengthening or weakening).
    (3) Accident years before 1986--(i) In general. For each taxable 
year beginning in 1986, the amount of reserve strengthening (weakening) 
for an unpaid loss reserve for an accident year before 1986 is the 
amount by which the reserve at the end of that taxable year exceeds (is 
less than)--
    (A) The reserve at the end of the immediately preceding taxable 
year; reduced by
    (B) Claims paid and loss adjustment expenses paid (``loss 
payments'') in the taxable year beginning in 1986 with respect to losses 
that are attributable to

[[Page 653]]

the reserve. The amount by which a reserve is reduced as a result of 
reinsurance ceded during a taxable year beginning in 1986 is treated as 
a loss payment made in that taxable year.
    (ii) Exceptions. Notwithstanding paragraph (c)(3)(i) of this 
section, the amount of reserve strengthening (weakening) for an unpaid 
loss reserve for an accident year before 1986 does not include--
    (A) An amount added to the reserve in a taxable year beginning in 
1986 as a result of a loss reported to the taxpayer from a mandatory 
state or federal assigned risk pool if the amount of the loss reported 
is not discretionary with the taxpayer; or
    (B) Payments made with respect to reinsurance assumed during a 
taxable year beginning in 1986 or amounts added to the reserve to take 
into account reinsurance assumed for a line of business during a taxable 
year beginning in 1986, but only to the extent that the amount does not 
exceed the amount of a hypothetical reserve for the reinsurance assumed. 
The amount of the hypothetical reserve is determined using the same 
assumptions (other than the assumed interest rates) that were used to 
determine a reserve for reinsurance assumed for the line of business in 
a taxable year beginning in 1985.
    (iii) Certain transactions deemed to be reinsurance assumed (ceded) 
in 1986. For purposes of this paragraph (c)(3), reinsurance assumed 
(ceded) in a taxable year beginning in 1985 is treated as assumed 
(ceded) during the succeeding taxable year if the appropriate unpaid 
loss reserve is not adjusted to take into account the reinsurance 
transaction until that succeeding taxable year.
    (d) Section 845. Any reinsurance transaction that has as one of its 
purposes the avoidance of the reserve strengthening limitation is 
subject to section 845.
    (e) Treatment of reserve strengthening. The fresh start provision of 
section 1023(e)(3)(A) of the 1986 Act does not apply to the portion of 
the taxpayer's unpaid losses attributable to reserve strengthening. 
Thus, the difference between the undiscounted unpaid losses attributable 
to reserve strengthening and the discounted unpaid losses attributable 
to reserve strengthening must be included in income and, therefore, 
included in earnings and profits for the first taxable year beginning 
after December 31, 1986. The amount that a taxpayer must include in 
income for its first taxable year beginning after December 31, 1986, as 
a result of reserve strengthening is equal to the excess (if any) of--
    (1) The sum of each amount of reserve strengthening multiplied by 
the difference between 100 percent and the discount factor that, under 
paragraph (b) of this section, is applicable to the unpaid loss reserve 
which was strengthened; over
    (2) The sum of each reserve weakening multiplied by the difference 
between 100 percent and the discount factor that, under paragraph (b) of 
this section, is applicable to the unpaid loss reserve which was 
weakened.
    (f) Examples. The following examples illustrate the principles of 
this section. For purposes of these examples, it is assumed that the 
taxpayers are property and casualty insurance companies that in 1987 did 
not elect to use their own historical loss payment patterns.

    Example 1. (i) As of the end of 1985, X, a calendar year taxpayer, 
had undiscounted unpaid losses of $1,000,000 in the workers' 
compensation line of business for the 1984 accident year. The same 
reserve had undiscounted unpaid losses of $900,000 at the end of 1986. 
During 1986, X's loss payments for this reserve were $300,000. 
Accordingly, under paragraph (c)(3)(i) of this section, X has a reserve 
strengthening of $200,000 ($900,000-($1,000,000-$300,000)).
    (ii) This was X's only reserve strengthening or weakening. Thus, 
under paragraph (e) of this section, for 1987 X must include in income 
$54,361.40 ($200,000  x  (100%-72.8193%)). The factor of 72.8193% is the 
AY+2 factor from the workers' compensation series of discount factors 
published in Rev. Rul. 87-34, 1987-1 C.B. 168.
    Example 2. The facts are the same as in Example 1, except that X's 
1986 loss payments for the reserve were $1,100,000. If only paragraph 
(c)(3)(i) of this section were applied, X would have a $1,000,000 
reserve strengthening ($900,000-($1,000,000-$1,100,000)). Under 
paragraph (c)(1) of this section, however, the amount of reserve 
strengthening for the reserve is limited to the amount of the reserve at 
the end of 1986. Accordingly, X has a reserve strengthening of $900,000 
and for 1987 must include in income $244,626.30 ($900,000  x  (100%-
72.1893%)).

[[Page 654]]

    Example 3. (i) As of the end of 1985, Y, a calendar year taxpayer, 
had undiscounted unpaid losses of $1,000,000 in the auto physical damage 
line of business for the 1985 accident year. The same reserve included 
undiscounted unpaid losses of $600,000 at the end of 1986. During 1986, 
Y had loss payments of $300,000 for this line of business. Under 
paragraph (c)(3)(i) of this section Y has a $100,000 reserve weakening 
($600,000-($1,000,000-$300,000)).
    (ii) Under paragraph (e) of this section, the only effect of the 
reserve weakening is to reduce the amount that Y is required to include 
in income as a result of any strengthening of another reserve.
    Example 4. The facts are the same as in Example 1 except that X also 
has a $100,000 reserve weakening for the 1985 accident year in its auto 
physical damage line of business. Under paragraph (b) of this section, 
the reserve discount factor for the reserve is 93.3400, the AY+1 factor 
from the auto physical damage series of discount factors published in 
Rev. Rul. 87-34. Thus, under paragraph (e) of this section, the amount 
that X is required to include in income in 1987 is reduced by $6,660 
($100,000  x  (100%-93.3400%)), resulting in an amount of $47,761.40 
($54,361.40-$6,660).
    Example 5. (i) At the end of 1985, Z, a calendar year taxpayer, had 
undiscounted unpaid losses of $1,000,000 in the workers' compensation 
line of business for the 1984 accident year. On May 1, 1986, Z ceded 
$130,000 of the reserve to an unrelated reinsurer. Z added $250,000 to 
the 1985 year end reserve to take into account workers' compensation 
risks for the 1984 accident year that Z assumed in a reinsurance 
transaction on September 1, 1986. Z had $230,000 of 1986 loss payments 
related to the 1984 accident year of its workers' compensation line, 
$60,000 of which was attributable to the reinsurance assumed by Z. At 
the end of 1986, Z's reserve for the workers' compensation line for the 
1984 accident year was $1,100,000.
    (ii) If only paragraph (c)(3)(i) of this section were applied, Z 
would have a $460,000 reserve strengthening ($1,100,000-($1,000,000-
$230,000-$130,000)). Under paragraph (c)(3)(ii)(B) of this section, 
however, reserve strengthening does not include the $250,000 that Z 
added to the reserve to take into account the reinsurance assumed. Also, 
none of the $60,000 of loss payments attributable to the reinsurance 
assumed in 1986 are taken into account. Accordingly, Z has $150,000 of 
reserve strengthening ($460,000-$250,000-$60,000). If this is Z's only 
reserve strengthening or weakening, then the amount that Z must include 
in income for 1987 under paragraph (e) of this section is $40,771.05 
($150,000  x  (100%-72.8193%)). The factor of 72.8193% is the AY+2 
factor from the workers' compensation series of discount factors 
published in Rev. Rul. 87-34.
    Example 6. (i) X was a calendar year taxpayer before July 1, 1986, 
the date on which X became a member of an affiliated group of 
corporations that files a consolidated return with a June 30 year end. 
Thus, X had two taxable years beginning in 1986: a short taxable year 
ending June 30, 1986, and a fiscal taxable year ending June 30, 1987.
    (ii) As of the end of 1985, X had undiscounted unpaid losses of 
$800,000 in the automobile liability line of business for the 1983 
accident year. At the end of the short taxable year, X had reserves of 
$700,000 of undiscounted unpaid losses, and on June 30, 1987, had 
reserves of $600,000 of undiscounted unpaid losses. During the short 
taxable year, ending June 30, 1986, X's loss payments for this reserve 
were $120,000. During the taxable year ending June 30, 1987, X's loss 
payments for this reserve were $180,000. Under paragraph (c)(3)(i) of 
this section, X has a $100,000 reserve strengthening: of which $20,000 
($700,000-($800,000-$120,000)) is attributable to the short taxable year 
ending June 30, 1986 and $80,000 ($600,000-($700,000-$180,000)) is 
attributable to the taxable year ending June 30, 1987.
    (iii) The amount of reserve strengthening for this line of business 
is determined pursuant to the principles of paragraph (c)(2) of this 
section.

[T.D. 8433, 57 FR 40845, Sept. 8, 1992; 57 FR 48563, Oct. 27, 1992; 57 
FR 57531, Dec. 4, 1992]



Sec. 1.846-4  Effective date.

    Sections 1.846-1 through Sections 1.846-3 apply to taxable years 
beginning after December 31, 1986.

[T.D. 8433, 57 FR 40847, Sept. 8, 1992]



Sec. 1.848-0  Outline of regulations under section 848.

    This section lists the paragraphs in Secs. 1.848-1 through 1.848-3.

              1.848-1  Definitions and special provisions.

(a) Scope and effective date.
    (b) Specified insurance contract.
    (1) In general.
    (2) Exceptions.
    (i) In general.
    (ii) Reinsurance of qualified foreign contracts.
    (c) Life insurance contract.
    (d) Annuity contract.
    (e) Noncancellable accident and health insurance contract.
    (f) Guaranteed renewable accident and health insurance contract.
    (g) Combination contract.
    (1) Definition.
    (2) Treatment of premiums on a combination contract.
    (i) In general.

[[Page 655]]

    (ii) De minimis premiums.
    (3) Example.
    (h) Group life insurance contract.
    (1) In general.
    (2) Group affiliation requirement.
    (i) In general.
    (ii) Employee group.
    (iii) Debtor group.
    (iv) Labor union group.
    (v) Association group.
    (vi) Credit union group.
    (vii) Multiple group.
    (viii) Certain discretionary groups.
    (ix) Employees treated as members.
    (x) Class or classes of a group determined without regard to 
individual health characteristics.
    (A) In general.
    (B) Limitation of coverage based on certain work and age 
requirements permissible.
    (3) Premiums determined on a group basis.
    (i) In general.
    (ii) Exception for substandard premium rates for certain high risk 
insureds.
    (iii) Flexible premium contracts.
    (iv) Determination of actual age.
    (4) Underwriting practices used by company. [Reserved]
    (5) Disqualification of group.
    (i) In general.
    (ii) Exception for de minimis failures.
    (6) Supplemental life insurance coverage.
    (7) Special rules relating to the payment of proceeds.
    (i) Contracts issued to a welfare benefit fund.
    (ii) Credit life insurance contracts.
    (iii) ``Organization or association'' limited to the sponsor of the 
contract or the group policyholder.
    (i) General deductions.

                 1.848-2  Determination of net premiums.

    (a) Net premiums.
    (1) In general.
    (2) Separate determination of net premiums for certain reinsurance 
agreements.
    (b) Gross amount of premiums and other consideration.
    (1) General rule.
    (2) Items included.
    (3) Treatment of premium deposits.
    (i) In general.
    (ii) Amounts irrevocably committed to the payment of premiums.
    (iii) Retired lives reserves.
    (4) Deferred and uncollected premiums.
    (c) Policy exchanges.
    (1) General rule.
    (2) External exchanges.
    (3) Internal exchanges resulting in fundamentally different 
contracts.
    (i) In general.
    (ii) Certain modifications treated as not changing the mortality, 
morbidity, interest, or expense guarantees.
    (iii) Exception for contracts restructured by a court supervised 
rehabilitation or similar proceeding.
    (4) Value of the contract.
    (i) In general.
    (ii) Special rule for group term life insurance contracts.
    (iii) Special rule for certain policy enhancement and update 
programs.
    (A) In general.
    (B) Policy enhancement or update program defined.
    (5) Example.
    (d) Amounts excluded from the gross amount of premiums and other 
consideration.
    (1) In general.
    (2) Amounts received or accrued from a guaranty association.
    (3) Exclusion not to apply to dividend accumulations.
    (e) Return premiums.
    (f) Net consideration for a reinsurance agreement.
    (1) In general.
    (2) Net consideration determined by a ceding company.
    (i) In general.
    (ii) Net negative and net positive consideration.
    (3) Net consideration determined by the reinsurer.
    (i) In general.
    (ii) Net negative and net positive consideration.
    (4) Timing consistency required.
    (5) Modified coinsurance and funds-withheld reinsurance agreements.
    (i) In general.
    (ii) Special rule for certain funds-withheld reinsurance agreements.
    (6) Treatment of retrocessions.
    (7) Mixed reinsurance agreements.
    (8) Treatment of policyholder loans.
    (9) Examples.
    (g) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements.
    (1) In general.
    (2) Application to reinsurance agreements subject to the interim 
rules.
    (3) Amount of reduction.
    (4) Capitalization shortfall.
    (5) Required capitalization amount.
    (i) In general.
    (ii) Special rule with respect to net negative consideration.
    (6) General deductions allocable to reinsurance agreements.
    (7) Allocation of capitalization shortfall among reinsurance 
agreements.
    (8) Election to determine specified policy acquisition expenses for 
an agreement without regard to general deductions limitation.
    (i) In general.
    (ii) Manner of making election.
    (iii) Election statement.

[[Page 656]]

    (iv) Effect of election.
    (9) Examples.
    (h) Treatment of reinsurance agreements with parties not subject to 
U.S. taxation.
    (1) In general.
    (2) Agreements to which this paragraph (h) applies.
    (i) In general.
    (ii) Parties subject to U.S. taxation.
    (A) In general.
    (B) Effect of a closing agreement.
    (3) Election to separately determine the amounts required to be 
capitalized for reinsurance agreements with parties not subject to U.S. 
taxation.
    (i) In general.
    (ii) Manner of making the election.
    (4) Amount taken into account for purposes of determining specified 
policy acquisition expenses.
    (5) Net foreign capitalization amount.
    (i) In general.
    (ii) Foreign capitalization amounts by category.
    (6) Treatment of net negative foreign capitalization amount.
    (i) Applies as a reduction to previously capitalized amounts.
    (ii) Carryover of remaining net negative foreign capitalization 
amount.
    (7) Reduction of net positive foreign capitalization amount by 
carryover amounts allowed.
    (8) Examples.
    (i) Carryover of excess negative capitalization amount.
    (1) In general.
    (2) Excess negative capitalization amount.
    (3) Treatment of excess negative capitalization amount.
    (4) Special rule for the treatment of an excess negative 
capitalization amount of an insolvent company.
    (i) When applicable.
    (ii) Election to forego carryover of excess negative capitalization 
amount.
    (iii) Amount of reduction to the excess negative capitalization 
amount and specified policy acquisition expenses.
    (iv) Manner of making election.
    (v) Presumptions relating to the insolvency of an insurance company 
undergoing a court supervised rehabilitation or similar state 
proceeding.
    (vi) Example.
    (j) Ceding commissions with respect to reinsurance of contracts 
other than specified insurance contracts.
    (k) Effective dates.
    (1) In general.
    (2) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements.
    (3) Net consideration rules.
    (4) Determination of the date on which a reinsurance agreement is 
entered into.
    (5) Special rule for certain reinsurance agreements with parties not 
subject to U.S. taxation.
    (6) Carryover of excess negative capitalization amount.

       1.848-3  Interim rules for certain reinsurance agreements.

    (a) Scope and effective dates.
    (b) Interim rules.
    (c) Adjustments and special rules.
    (1) Assumption reinsurance.
    (2) Reimbursable dividends.
    (3) Ceding commissions.
    (i) In general.
    (ii) Amount of ceding commission.
    (4) Termination payments.
    (5) Modified coinsurance agreements.
    (d) Examples.

[T.D. 8456, 57 FR 61818, Dec. 29, 1992]



Sec. 1.848-1  Definitions and special provisions.

    (a) Scope and effective date. The definitions and special provisions 
in this section apply solely for purposes of determining specified 
policy acquisition expenses under section 848 of the Internal Revenue 
Code, this section, and Secs. 1.848-2 and 1.848-3. Unless otherwise 
specified, the rules of this section are effective for the taxable years 
of an insurance company beginning after November 14, 1991.
    (b) Specified insurance contract--(1) In general. A ``specified 
insurance contract'' is any life insurance contract, annuity contract, 
noncancellable or guaranteed renewable accident and health insurance 
contract, or combination contract. A reinsurance agreement that 
reinsures the risks under a specified insurance contract is treated in 
the same manner as the reinsured contract.
    (2) Exceptions--(i) In general. A ``specified insurance contract'' 
does not include any pension plan contract (as defined in section 
818(a)), flight insurance or similar contract, or qualified foreign 
contract (as defined in section 807(e)(4)).
    (ii) Reinsurance of qualified foreign contracts. The exception for 
qualified foreign contracts does not apply to reinsurance agreements 
that reinsure qualified foreign contracts.
    (c) Life insurance contract. A ``life insurance contract'' is any 
contract--

[[Page 657]]

    (1) Issued after December 31, 1984, that qualifies as a life 
insurance contract under section 7702(a) (including an endowment 
contract as defined in 7702(h)); or
    (2) Issued prior to January 1, 1985, if the premiums on the contract 
are reported as life insurance premiums on the insurance company's 
annual statement (or could be reported as life insurance premiums if the 
company were required to file the annual statement for life and accident 
and health companies).
    (d) Annuity contract. An ``annuity contract'' is any contract (other 
than a life insurance contract as defined in paragraph (c) of this 
section) if amounts received under the contract are subject to the rules 
in section 72(b) or section 72(e) (determined without regard to section 
72(u)). The term ``annuity contract'' also includes a contract that is a 
qualified funding asset under section 130(d).
    (e) Noncancellable accident and health insurance contract. The term 
``noncancellable accident and health insurance contract'' has the same 
meaning for purposes of section 848 as the term has for purposes of 
section 816(b).
    (f) Guaranteed renewable accident and health insurance contract. The 
term ``guaranteed renewable accident and health insurance contract'' has 
the same meaning for purposes of section 848 as the term has for 
purposes of section 816(e).
    (g) Combination contract--(1) Definition. A ``combination contract'' 
is a contract (other than a contract described in section 848(e)(3)) 
that provides two or more types of insurance coverage, at least one of 
which if offered separately would be a life insurance contract, an 
annuity contract, or a noncancellable or guaranteed renewable accident 
and health insurance contract.
    (2) Treatment of premiums on a combination contract--(i) In general. 
If the premium allocable to each type of insurance coverage is 
separately stated on the insurance company's annual statement (or could 
be separately stated if the insurance company were required to file the 
annual statement for life and accident and health companies), the 
premium allocable to each type of insurance coverage in a combination 
contract is subject to the capitalization rate, if any, that would apply 
if that coverage was provided in a separate contract. If the premium 
allocable to each type of insurance coverage in a combination contract 
is not separately stated, the entire premium is subject to the highest 
capitalization percentage applicable to any of the coverages provided.
    (ii) De minimis premiums. For purposes of this paragraph (g)(2)--
    (A) A de minimis premium is not required to be separately stated;
    (B) In determining the highest capitalization percentage applicable 
to a combination contract, the coverage to which a de minimis premium is 
allocable is disregarded;
    (C) If the separate statement requirement of this paragraph (g)(2) 
is satisfied, a de minimis premium is treated in accordance with its 
characterization on the insurance company's annual statement; and
    (D) Whether a premium for an insurance coverage is de minimis is 
determined by comparing that premium with the aggregate of the premiums 
for the combination contract. A premium that is not more than 2 percent 
of the premium for the entire contract is considered de minimis. Whether 
a premium that is more than 2 percent is de minimis is determined based 
on all the facts and circumstances.
    (3) Example. The principles of this paragraph (g) are illustrated by 
the following example.

    Example. A life insurance company (L1) issues a contract to an 
employer (X) which provides cancellable accident and health insurance 
coverage and group term life insurance coverage to X's employees. L1 
charges a premium of $1,000 for the contract, $950 of which is 
attributable to the cancellable accident and health insurance coverage 
and $50 of which is attributable to the group term life insurance 
coverage. On its annual statement, L1 reports the premiums attributable 
to the accident and health insurance coverage separately from the 
premiums attributable to the group term life insurance coverage. The 
contract issued by L1 is a combination contract as defined in paragraph 
(g)(1) of this section. Pursuant to paragraph (g)(2)(i) of this section, 
only the premiums attributable to the group term life insurance coverage 
($50) are subject to the provisions of

[[Page 658]]

section 848. The premiums attributable to the cancellable accident and 
health insurance coverage ($950) are not subject to the provisions of 
section 848.

    (h) Group life insurance contract--(1) In general. A life insurance 
contract (as defined in paragraph (c) of this section) is group life 
insurance contract if--
    (i) The contract is a group life insurance contract under the 
applicable law;
    (ii) The coverage is provided under a master contract issued to the 
group policyholder, which may be a trust, trustee, or agent;
    (iii) The premiums on the contract are reported either as group life 
insurance premiums or credit life insurance premiums on the insurance 
company's annual statement (or could be reported as group life insurance 
premiums or credit life insurance premiums if the company were required 
to file the annual statement for life and accident and health 
companies);
    (iv) The group affiliation requirement of paragraph (h)(2) of this 
section is satisfied;
    (v) The premiums on the contract are determined on a group basis 
within the meaning of paragraph (h)(3) of this section; and
    (vi) The proceeds of the contract are not payable to or for the 
benefit of the insured's employer, an organization or association to 
which the insured belongs, or other similar person. (See paragraph 
(h)(7) of this section for special rules that apply in determining if 
this requirement is satisfied.)
    (2) Group affiliation requirement--(i) In general. The group 
affiliation requirement of section 848(e)(2)(A) and this paragraph 
(h)(2) is satisfied only if all of the individuals eligible for coverage 
under the contract constitute a group described in paragraphs (h)(2) 
(ii) through (viii) of this section.
    (ii) Employee group. An employee group consists of all of the 
employees (including statutory employees within the meaning of section 
3121(d)(3) and individuals who are treated as employed by a single 
employer under section 414 (b), (c), or (m)), or any class or classes 
thereof within the meaning of paragraph (h)(2)(x) of this section, of an 
employer. For this purpose, the term ``employee'' includes--
    (A) A retired or former employee;
    (B) The sole proprietor, if the employer is a sole proprietorship;
    (C) A partner of the partnership, if the employer is a partnership;
    (D) A director of the corporation, if the employer is a corporation; 
and
    (E) An elected or appointed official of the public body, if the 
employer is a public body.
    (iii) Debtor group. A debtor group consists of all of the debtors, 
or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of a creditor. For this purpose, the term 
``debtor'' includes a borrower of money or purchaser or lessee of goods, 
services, or property for which payment is arranged through a credit 
transaction.
    (iv) Labor union group. A labor union group consists of all of the 
members, or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of a labor union or similar employee 
organization.
    (v) Association group. An association group consists of all of the 
members, or any class or classes thereof within the meaning of paragraph 
(h)(2)(x) of this section, of an association that, at the time the 
master contract is issued--
    (A) Is organized and maintained for purposes other than obtaining 
insurance;
    (B) Has been in active existence for at least two years (including, 
in the case of a merged or successor association, the years of active 
existence of any predecessor association); and
    (C) Has at least 100 members.
    (vi) Credit union group. A credit union group consists of all of the 
members or borrowers, or any class or classes thereof within the meaning 
of paragraph (h)(2)(x) of this section, of a credit union.
    (vii) Multiple group. A multiple group consists of two or more 
groups from any single category described in paragraphs (h)(2) (ii) 
through (vi) of this section. A multiple group may not include two or 
more groups from different categories described in paragraph (h)(2) (ii) 
through (vi) of this section.
    (viii) Certain discretionary groups. Provided that the contract 
otherwise satisfies the requirements of paragraph (h)(1) of this 
section, a contract issued to one of the following discretionary

[[Page 659]]

groups is treated as satisfying the group affiliation requirement of 
this paragraph (h)(2)--
    (A) A contract issued to a group consisting of students of one or 
more universities or other educational institutions;
    (B) A contract issued to a group consisting of members or former 
members of the U.S. Armed Forces;
    (C) A contract issued to a group of individuas for the payment of 
future funeral expenses; and
    (D) A contract issued to any other discretionary group as specified 
by the Commissioner in subsequent guidance published in the Internal 
Revenue Bulletin. (See Sec. 601.601(d)(2)(ii)(b) of this chapter.)
    (ix) Employees treated as members. In determining whether the group 
affiliation requirement of paragraph (h)(2) of this section is 
satisfied, the employees of a labor union, credit union, or association 
may be treated as members of a labor union group, a credit union group, 
or an association group, respectively.
    (x) Class or classes of a group determined without regard to 
individual health characteristics--(A) In general. A class or classes of 
a group described in paragraphs (h)(2) (ii) through (viii) of this 
section may be determined using any reasonable characteristics (for 
example, amount of insurance, location, or occupation) other than 
individual health characteristics. The employees of a single employer 
covered under a policy issued to a multi-employer trust are considered a 
class of a group described in paragraph (h)(2)(ii) of this section.
    (B) Limitation of coverage based on certain work and age 
requirements permissible. A limitation of coverage under a group 
contract to persons who are actively at work or of a pre-retirement age 
(for example, age 65 or younger) is not treated as based on individual 
health characteristics.
    (3) Premiums determined on a group basis--(i) In general. Premiums 
for a contract are determined on a group basis for purposes of section 
848(e)(2)(B) and this paragraph (h) only if the premium charged by the 
insurance company for each member of the group (or any class thereof) is 
determined on the basis of the same rates for the corresponding amount 
of coverage (for example, per $1,000 of insurance) or on the basis of 
rates which differ only because of the gender, smoking habits, or age of 
the member.
    (ii) Exception for substandard premium rates for certain high risk 
insureds. Any difference in premium rates is disregarded for purposes of 
this paragraph (h)(3) if the difference is charged for an individual who 
was accepted for coverage at a substandard rate prior to January 1, 
1993.
    (iii) Flexible premium contracts. In the case of a group universal 
life insurance contract, the identical premium requirement is satisfied 
if the premium rates used by the insurance company in determining the 
periodic mortality charges applied to the policy account value of any 
member insured by the contract differ from those of other members 
(within the same class) only because of the gender, smoking habits, or 
age of the member.
    (iv) Determination of actual age. For purposes of this paragraph 
(h)(3), determinations of actual age may be made using any reasonable 
method, provided that this method is applied consistently for all 
members of the group.
    (4) Underwriting practices used by company. [Reserved]
    (5) Disqualification of group--(i) In general. Except as otherwise 
provided in this paragraph (h)(5), if the requirements of paragraphs 
(h)(1), (2), and (3) of this section are not satisfied with respect to 
one or more members of the group, or of a class within a group (within 
the meaning of paragraph (h)(2)(x) of this section), the premiums for 
the entire group (or class) are treated as individual life insurance 
premiums.
    (ii) Exception for de minimis failures. If the requirements of 
paragraphs (h) (1), (2), or (3) of this section are not satisfied with 
respect to one or more members of the group (or class), but the sum of 
the premiums charged by the insurance company for those individuals is 
no more than 5 percent of the aggregate premiums for the group (or 
class), only the premiums charged for those individuals are treated as 
premiums for an individual life insurance contract.

[[Page 660]]

    (6) Supplemental life insurance coverage. For purposes of 
determining whether the requirement in paragraph (h)(3)(i) of this 
section is satisfied, any supplemental life insurance coverage 
(including optional coverage for members of the group, their spouses, or 
their dependent children) is (or is treated as) a separate contract. In 
determining whether the group affiliation requirement of paragraph 
(h)(2) of this section is satisfied for the supplemental coverage, a 
member's spouse and dependent children are treated as members of the 
group if they are eligible for coverage.
    (7) Special rules relating to the payment of proceeds. The following 
rules apply for purposes of section 848(e)(2) and paragraph (h)(1)(vi) 
of this section.
    (i) Contracts issued to a welfare benefit fund. If a contract issued 
to a welfare benefit fund (as defined in section 419) provides for 
payment of proceeds to the welfare benefit fund, the proceeds of the 
contract are not considered payable to or for the benefit of the 
insured's employer, an organization or association to which the insured 
belongs, or other similar person, provided the proceeds are paid as 
benefits to the employee or the employee's beneficiary.
    (ii) Credit life insurance contracts. If a credit life insurance 
contract provides for payment of proceeds to the insured's creditor, the 
proceeds of the contract are not treated as payable to or for the 
benefit of the insured's employer, an organization or association to 
which the insured belongs, or other similar person, provided the 
proceeds are applied against an outstanding indebtedness of the insured.
    (iii) ``Organization or association'' limited to the sponsor of the 
contract or the group policyholder. The term ``organization or 
association'' means the organization or association that is either the 
sponsor of the contract or the group policyholder.
    (i) General deductions. The term ``general deductions'' is defined 
in section 848(c)(2). An insurance company determines its general 
deductions for the taxable year without regard to amounts capitalized or 
amortized under section 848(a). The amount of a company's general 
deductions is also determined without regard to the rules of Sec. 1.848-
2(f), which apply only for purposes of determining net consideration for 
reinsurance agreements.

[T.D. 8456, 57 FR 61819, Dec. 29, 1992; 58 FR 9245, Feb. 19, 1993]



Sec. 1.848-2  Determination of net premiums.

    (a) Net premiums--(1) In general. An insurance company must use the 
accrual method of accounting (as prescribed by section 811(a)(1)) to 
determine the net premiums with respect to each category of specified 
insurance contracts. With respect to any category of contracts, net 
premiums means--
    (i) The gross amount of premiums and other consideration (see 
paragraph (b) of this section); reduced by
    (ii) The sum of--
    (A) The return premiums (see paragraph (e) of this section); and
    (B) The net negative consideration for a reinsurance agreement 
(other than an agreement described in paragraph (h)(2) of this section). 
See paragraphs (f) and (g) of this section for rules relating to the 
determination of net negative consideration.
    (2) Separate determination of net premiums for certain reinsurance 
agreements. Net premiums with respect to reinsurance agreements for 
which an election under paragraph (h)(3) of this section has been made 
(certain reinsurance agreements with parties not subject to United 
States taxation) are treated separately and are subject to the rules of 
paragraph (h) of this section.
    (b) Gross amount of premiums and other consideration--(1) General 
rule. The term ``gross amount of premiums and other consideration'' 
means the sum of--
    (i) All premiums and other consideration (other than amounts on 
reinsurance agreements); and
    (ii) The net positive consideration for any reinsurance agreement 
(other than an agreement for which an election under paragraph (h)(3) of 
this section has been made).
    (2) Items included. The gross amount of premiums and other 
consideration includes--
    (i) Advance premiums;
    (ii) Amounts in a premium deposit fund or similar account, to the 
extent

[[Page 661]]

provided in paragraph (b)(3) of this section;
    (iii) Fees;
    (iv) Assessments;
    (v) Amounts that the insurance company charges itself representing 
premiums with respect to benefits for its employees (including full-time 
life insurance salesmen treated as employees under section 7701(a)(20)); 
and
    (vi) The value of a new contract issued in an exchange described in 
paragraph (c)(2) or (c)(3) of this section.
    (3) Treatment of premium deposits--(i) In general. An amount in a 
premium deposit fund or similar account is taken into account in 
determining the gross amount of premiums and other consideration at the 
earlier of the time that the amount is applied to, or irrevocably 
committed to, the payment of a premium on a specified insurance 
contract. If an amount is irrevocably committed to the payment of a 
premium on a specified insurance contract, then neither that amount nor 
any earnings allocable to that amount are included in the gross amount 
of premiums and other consideration when applied to the payment of a 
premium on the same contract.
    (ii) Amounts irrevocably committed to the payment of premiums. 
Except as provided in paragraph (b)(3)(iii) of this section, an amount 
in a premium deposit fund or similar account is irrevocably committed to 
the payment of premiums on a contract only if neither the amount nor any 
earnings allocable to that amount may be--
    (A) Returned to the policyholder or any other person (other than on 
surrender of the contract); or
    (B) Used by the policyholder to fund another contract.
    (iii) Retired lives reserves. Premiums received by an insurance 
company under a retired lives reserve arrangement are treated as 
irrevocably committed to the payment of premiums on a specified 
insurance contract.
    (4) Deferred and uncollected premiums. The gross amount of premiums 
and other consideration does not include deferred and uncollected 
premiums.
    (c) Policy exchanges--(1) General rule. Except as otherwise provided 
in this paragraph (c), an exchange of insurance contracts (including a 
change in the terms of a specified insurance contract) does not result 
in any amount being included in the gross amount of premiums and other 
consideration.
    (2) External exchanges. If a contract is exchanged for a specified 
insurance contract issued by another insurance company, the company that 
issues the new contract must include the value of the new contract in 
the gross amount of premiums and other consideration.
    (3) Internal exchanges resulting in fundamentally different 
contracts--(i) In general. If a contract is exchanged for a specified 
insurance contract issued by the same insurance company that issued the 
original contract, the company must include the value of the new 
contract in the gross amount of premiums and other consideration if the 
new contract--
    (A) Relates to a different category of specified insurance contract 
than the original contract;
    (B) Does not cover the same insured as the original contract; or
    (C) Changes the interest, mortality, morbidity, or expense 
guarantees with respect to the nonforfeiture benefits provided in the 
original contract.
    (ii) Certain modifications treated as not changing the mortality, 
morbidity, interest, or expense guarantees. For purposes of paragraph 
(c)(3)(i)(C) of this section, the following items are not treated as 
changing the interest, mortality, morbidity, or expense guarantees with 
respect to the nonforfeiture benefits provided in the contract--
    (A) A change in a temporary guarantee with respect to the amounts to 
be credited as interest to the policyholder's account, or charged as 
mortality, morbidity, or expense charges, if the new guarantee applies 
for a period of ten years or less;
    (B) The determination of benefits on annuitization using rates which 
are more favorable to the policyholder than the permanently guaranteed 
rates; and
    (C) Other items as specified by the Commissioner in subsequent 
guidance published in the Internal Revenue Bulletin.
    (iii) Exception for contracts restructured by a court supervised 
rehabilitation

[[Page 662]]

or similar proceeding. No amount is included in the gross amount of 
premiums and other consideration with respect to any change made to the 
interest, mortality, morbidity, or expense guarantees with respect to 
the nonforfeiture benefits of contracts of an insurance company that is 
the subject of a rehabilitation, conservatorship, insolvency, or similar 
state proceeding. This treatment applies only if the change--
    (A) Occurs as part of the rehabilitation, conservatorship, 
insolvency, or similar state proceeding; and
    (B) Is approved by the state court, the state insurance department, 
or other state official with authority to act in the rehabilitation, 
conservatorship, insolvency, or similar state proceeding.
    (4) Value of the contract--(i) In general. For purposes of paragraph 
(c)(2) or (c)(3) of this section, the value of the new contract is 
established through the most recent sale by the company of a comparable 
contract. If the value of the new contract is not readily ascertainable, 
the value may be approximated by using the interpolated terminal reserve 
of the original contract as of the date of the exchange.
    (ii) Special rule for group term life insurance contracts. In the 
case of any exchange involving a group term life insurance contract 
without cash value, the value of the new contract is deemed to be zero.
    (iii) Special rule for certain policy enhancement and update 
programs--(A) In general. If the interest, mortality, morbidity, or 
expense guarantees with respect to the nonforfeiture benefits of a 
specified insurance contract are changed pursuant to a policy 
enhancement or update program, the value of the contract included in the 
gross amount of premiums and other consideration equals 30 percent of 
the value determined under paragraph (c)(4) of this section.
    (B) Policy enhancement or update program defined. For purposes of 
paragraph (c)(4)(iii)(A) of this section, a policy enhancement or update 
program means any offer or commitment by the insurance company to all of 
the policyholders holding a particular policy form to change the 
interest, mortality, morbidity, or expense guarantees used to determine 
the contract's nonforfeiture benefits.
    (5) Example. The principles of this paragraph (c) are illustrated by 
the following example.

    Example. (i) An individual (A) owns a life insurance policy issued 
by a life insurance company (L1). On January 1, 1993, A purchases 
additional term insurance for $250, which is added as a rider to A's 
life insurance policy. The purchase of the additional term insurance 
does not change the interest mortality, morbidity, or expense guarantees 
with respect to the nonforfeiture benefits provided by A's life 
insurance policy.
    (ii) A's purchase of the term insurance rider is not considered to 
result in a fundamentally different contract under paragraph (c)(3) of 
this section because the addition of the rider did not change the 
interest, mortality, morbidity, or expense guarantees with respect to 
the nonforfeiture values of A's original life insurance policy. 
Therefore, L1 includes only the $250 received from A in the gross amount 
of premiums and other consideration.

    (d) Amounts excluded from the gross amount of premiums and other 
consideration--(1) In general. The following items are not included in 
the gross amount of premiums and other consideration--
    (i) Items treated by section 808(e) as policyholder dividends that 
are paid to the policyholder and immediately returned to the insurance 
company as a premium on the same contract that generated the dividends, 
including--
    (A) A policyholder dividend applied to pay a premium under the 
contract that generated the dividend;
    (B) Excess interest accumulated within the contract;
    (C) A policyholder dividend applied for additional coverage (for 
example, a paid-up addition, extension of the period for which insurance 
protection is provided, or reduction of the period for which premiums 
are paid) on the contract that generated the dividend;
    (D) A policyholder dividend applied to reduce premiums otherwise 
payable on the contract that generated the dividend;
    (E) An experience-rated refund applied to pay a premium on the group 
contract that generated the refund; and

[[Page 663]]

    (F) An experience-rated refund applied to a premium stabilization 
reserve held with respect to the group contract that generated the 
refund;
    (ii) Premiums waived as a result of the disability of an insured or 
the disability or death of a premium payor;
    (iii) Premiums considered to be paid on a contract as the result of 
a partial surrender or withdrawal from the contract, or as a result of 
the surrender or withdrawal of a paid-up addition previously issued with 
respect to the same contract; and
    (iv) Amounts treated as premiums upon the selection by a 
policyholder or by a beneficiary of a settlement option provided in a 
life insurance contract.
    (2) Amounts received or accrued from a guaranty association. Amounts 
received or accrued from a guaranty association relating to an insurance 
company that is subject to an insolvency, delinquency, conservatorship, 
rehabilitation, or similar proceeding are not included in the gross 
amount of premiums and other consideration.
    (3) Exclusion not to apply to dividend accumulations. For purposes 
of section 848(d)(3) and paragraph (d)(1) of this section, amounts 
applied from a dividend accumulation account to pay premiums on a 
specified insurance contract are not amounts treated as paid to, and 
immediately returned by, the policyholder.
    (e) Return premiums. For purposes of section 848(d)(1)(B) and this 
section, return premiums do not include policyholder dividends (as 
defined in section 808), claims or benefits payments, or amounts 
returned to another insurance company under a reinsurance agreement. For 
the treatment of amounts returned to another insurance company under a 
reinsurance agreement, see paragraph (f) of this section.
    (f) Net consideration for a reinsurance agreement--(1) In general. 
For purposes of section 848, the ceding company and the reinsurer must 
treat amounts arising from the reinsurance of a specified insurance 
contract consistently in determining their net premiums. See paragraph 
(g) of this section for restrictions on the amount of the net negative 
consideration for any reinsurance agreement that may be taken into 
account. See paragraph (h) of this section for special rules applicable 
to reinsurance agreements with parties not subject to United States 
taxation.
    (2) Net consideration determined by a ceding company--(i) In 
general. The net consideration determined by a ceding company for a 
reinsurance agreement equals--
    (A) The gross amount incurred by the reinsurer with respect to the 
reinsurance agreement, including any ceding commissions, annual 
allowances, reimbursements of claims and benefits, modified coinsurance 
reserve adjustments under paragraph (f)(5) of this section, experience-
rated adjustments, and termination payments; less
    (B) The gross amount of premiums and other consideration incurred by 
the ceding company with respect to the reinsurance agreement.
    (ii) Net negative and net positive consideration. If the net 
consideration is less than zero, the ceding company has net negative 
consideration for the reinsurance agreement. If the net consideration is 
greater than zero, the ceding company has net positive consideration for 
the reinsurance agreement.
    (3) Net consideration determined by the reinsurer--(i) In general. 
The net consideration determined by a reinsurer for a reinsurance 
agreement equals--
    (A) The amount described in paragraph (f)(2)(i)(B) of this section; 
less
    (B) The amount described in paragraph (f)(2)(i)(A) of this section.
    (ii) Net negative and net positive consideration. If the net 
consideration is less than zero, the reinsurer has net negative 
consideration for the reinsurance agreement. If the net consideration is 
greater than zero, the reinsurer has net positive consideration for the 
reinsurance agreement.
    (4) Timing consistency required. For purposes of determining the net 
consideration of a party for a reinsurance agreement, an income or 
expense item is taken into account for the first taxable year for which 
the item is required to be taken into account by either party. Thus, the 
ceding company and the reinsurer must take the item into account for the 
same taxable year (or for the same period if the parties have different 
taxable years).
    (5) Modified coinsurance and funds-withheld reinsurance agreements--
(i) In

[[Page 664]]

general. In the case of a modified coinsurance or funds-withheld 
reinsurance agreement, the net consideration for the agreement includes 
the amount of any payments or reserve adjustments, as well as any 
related loan transactions between the ceding company and the reinsurer. 
The amount of any investment income transferred between the parties as 
the result of a reserve adjustment or loan transaction is treated as an 
item of consideration under the reinsurance agreement.
    (ii) Special rule for certain funds-withheld reinsurance agreements. 
In the case of a funds-withheld reinsurance agreement that is entered 
into after November 14, 1991, but before the first day of the first 
taxable year beginning after December 31, 1991, and is terminated before 
January 1, 1995, the parties' net consideration in the year of 
termination must include the amount of the original reserve for any 
reinsured specified insurance contract that, in applying the provisions 
of subchapter L, was treated as premiums and other consideration 
incurred for reinsurance for the taxable year in which the agreement 
became effective.
    (6) Treatment of retrocessions. For purposes of this paragraph (f), 
a retrocession agreement is treated as a separate reinsurance agreement. 
The party that is relieved of liability under a retrocession agreement 
is treated as the ceding company.
    (7) Mixed reinsurance agreement. If a reinsurance agreement includes 
more than one category of specified insurance contracts (or specified 
insurance contracts and contracts that are not specified insurance 
contracts), the portion of the agreement relating to each category of 
reinsured specified insurance contracts is treated as a separate 
agreement. The portion of the agreement relating to reinsured contracts 
that are not specified insurance contracts is similarly treated as a 
separate agreement.
    (8) Treatment of policyholder loans. For purposes of determining the 
net consideration under a reinsurance agreement, the transfer of a 
policyholder loan receivable is treated as an item of consideration 
under the agreement. The interest credited with respect to a 
policyholder loan receivable is treated as investment income earned 
directly by the party holding the receivable. The amounts taken into 
account as claims and benefit reimbursements under the agreement must be 
determined without reduction for the policyholder loan.
    (9) Examples. The principles of this paragraph (f) are illustrated 
by the following examples.

    Example 1. On July 1, 1992, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated life 
insurance company (L2) under an agreement whereby L2 becomes solely 
liable to the policyholders under the contracts reinsured. L1 and L2 are 
calendar year taxpayers. Under the assumption reinsurance agreement, L1 
agrees to pay L2 $100,000 for assuming the life insurance contracts, and 
L2 agrees to pay L1 a $17,000 ceding commission. Under paragraph (f)(2) 
of this section, L1 has net negative consideration of ($83,000) ($17,000 
ceding commission incurred by L2--$100,000 incurred by L1 for 
reinsurance). Under paragraph (f)(3) of this section, L2 has net 
positive consideration of $83,000. Under paragraph (b)(1)(ii) of this 
section, L2 includes the net positive consideration in its gross amount 
of premiums and other consideration.
    Example 2. (i) On July 1, 1992, a life insurance company (L1) 
transfers a block of individual life insurance contracts to an unrelated 
life insurance company (L2) under an agreement whereby L1 remains liable 
to the policyholders under the reinsured contracts. L1 and L2 are 
calendar year taxpayers. Under the indemnity reinsurance agreement, L1 
agrees to pay L2 $100,000 for reinsuring the life insurance contracts, 
and L2 agrees to pay L1 a $17,000 ceding commission. L1 agrees to pay L2 
an amount equal to the future premiums on the reinsured contracts. L2 
agrees to indemnify L1 for claims and benefits and administrative 
expenses incurred by L1 while the reinsurance agreement is in effect.
    (ii) For the period beginning July 1, 1992, and ending December 31, 
1992, the following income and expense items are determined with respect 
to the reinsured contracts:

------------------------------------------------------------------------
                       Item                           Income    Expense 
------------------------------------------------------------------------
Premiums..........................................    $25,000  .........
Death benefits....................................  .........    $10,000
Surrender benefits................................  .........      8,000
Premium taxes and other expenses..................  .........      2,000
                                                              ----------
      Total.......................................  .........     20,000
------------------------------------------------------------------------


    (iii) Under paragraph (f)(2) of this section, L1's net negative 
consideration equals ($88,000), which is determined by subtracting the 
$125,000 ($100,000 + $25,000) incurred by L1

[[Page 665]]

from the $37,000 incurred by L2 under the reinsurance agreement ($17,000 
+ $10,000 + $8,000 + $2,000). L2's net positive consideration is 
$88,000. Under paragraph (b)(1)(ii) of this section, L2 includes the 
$88,000 net positive consideration in its gross amount of premiums and 
other consideration.
    Example 3. (i) Assume that the reinsurance agreement referred to in 
Example 2 is terminated on December 31, 1993. During the period from 
January 1, 1993 through December 31, 1993, the following income and 
expense items are determined with respect to the reinsured contracts:

------------------------------------------------------------------------
                       Item                           Income    Expense 
------------------------------------------------------------------------
Premiums..........................................    $45,000  .........
Death benefits....................................  .........    $18,000
Surrender benefits................................  .........      6,000
Premium taxes and other expenses..................  .........      8,000
                                                              ----------
      Total.......................................  .........     32,000
------------------------------------------------------------------------


    (ii) On the termination of the reinsurance agreement, L1 receives a 
payment of $70,000 from L2 as consideration for releasing L2 from 
liability with respect to the reinsured contracts.
    (iii) L1's net positive consideration equals $57,000, which is the 
excess of the $102,000 incurred by L2 for the year ($18,000 + $6,000 + 
$8,000 + $70,000) over the $45,000 incurred by L1. L2's net negative 
consideration is ($57,000). L1 includes the net positive consideration 
in its gross amount of premiums and other consideration.
    Example 4. (i) On January 1, 1993, an insurance company (L1) enters 
into a modified coinsurance agreement with another insurance company 
(L2), covering a block of individual life insurance contracts. Both L1 
and L2 are calendar year taxpayers. Under the agreement, L2 is credited 
with an initial reinsurance premium equal to L1's reserves on the 
reinsured contracts at the inception of the agreement, any new premiums 
received with respect to the reinsured contracts, any decrease in L1's 
reserves on the reinsured contracts, and an amount of investment income 
determined by reference to L1's reserves on the reinsured contracts. L2 
is charged for all claims and expenses incurred with respect to the 
reinsured contracts plus an amount reflecting any increase in L1's 
reserves. The agreement further provides that cash settlements between 
the parties are made at the inception and termination of the agreement, 
as well as at the end of each calendar year while the agreement is in 
effect. The cash settlement is determined by netting the sum of the 
amounts credited to L2 against the sum of the amounts charged to L2 with 
respect to the reinsured policies. L1's reserves on the reinsured 
policies at the inception of the reinsurance agreement are $375,000.
    (ii) Under the cash settlement formula, L2 is credited with an 
initial reinsurance premium equal to L1's reserves on the reinsured 
policies ($375,000), but is charged an amount reflecting L1's policy 
reserve requirements ($375,000).
    (iii) For the period ending December 31, 1993, L2 is also credited 
and charged the following amounts with respect to the reinsured 
contracts.

------------------------------------------------------------------------
                       Item                           Income    Expense 
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Investment income.................................     39,000  .........
Death benefits....................................  .........    $65,000
Increase in reserves..............................  .........     75,000
------------------------------------------------------------------------

    (iv) Under paragraph (f)(5) of this section, L2's net negative 
consideration for the 1993 taxable year equals ($1,000) which is 
determined by subtracting the sum of the amounts charged to L2 ($375,000 
+ $65,000 + $75,000 = $515,000) from the sum of the amounts credited to 
L2 ($375,000 + $100,000 + $39,000 = $514,000). L1's net positive 
consideration for calendar year 1993 equals $1,000. Under paragraph 
(b)(1)(ii) of this section, L1 includes the $1,000 net positive 
consideration in its gross amount of premiums and other consideration.
    Example 5. (i) On January 1, 1993, an insurance company (L1) enters 
into a coinsurance agreement with another insurance company (L2) 
covering a block of individual life insurance contracts. Both L1 and L2 
are calendar year taxpayers. Under the agreement, L2 is credited with an 
initial reinsurance premium equal to L1's reserves on the effective date 
of the agreement, any new premiums received on the reinsured contracts, 
but must indemnify L1 of all claims and expenses incurred with respect 
to the contracts. As part of the agreement, L2 makes a loan to L1 equal 
to the amount of the reserves on the reinsured contracts. L1's reserves 
on the reinsured contracts on the effective date of the agreement are 
$375,000. Thus, on the inception date of the reinsurance agreement, L1 
transfers to L2 its note for $375,000 as consideration for reinsurance.
    (ii) The reinsurance agreement between L1 and L2 is a funds-withheld 
reinsurance agreement. Under paragraph (f)(5) of this section, the 
amount of any loan transaction is taken into account in determining the 
parties' net consideration. At the inception of the reinsurance 
agreement, L2 is credited with a reinsurance premium equal to L1's 
reserves on the reinsured contracts ($375,000). L2's $375,000 loan to L1 
is treated as an amount returned to L1 under the agreement.
    (iii) For the period ending December 31, 1993, L2 is credited and 
charged the following amounts with respect to the reinsured contracts 
and the loan transaction with L1.

[[Page 666]]



------------------------------------------------------------------------
                       Item                           Income    Expense 
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Accrued interest..................................     39,000  .........
Death benefits....................................  .........    $65,000
Increase in loan to L1............................  .........     75,000
------------------------------------------------------------------------

    (iv) Under paragraph (f)(5) of this section, L2's net negative 
consideration for the 1993 taxable year equals ($1,000), which is 
determined by subtracting the sum of amounts incurred by L2 with respect 
to death benefits and the loan transaction ($375,000 + $65,000 + $75,000 
= $515,000) from the sum of the amounts credited to L2 as reinsurance 
premiums and interest on the loan transaction ($375,000 + $100,000 + 
39,000 = $514,000). L1's net positive consideration for calendar year 
1993 equals $1,000. Under paragraph (b)(1)(ii) of this section, L1 
includes the $1,000 net positive consideration in its gross amount of 
premiums and other consideration.
    Example 6. (i) On December 31, 1993, an insurance company (L1) 
enters into a reinsurance agreement with another insurance company (L2) 
covering a block of individual life insurance contracts. Both L1 and L2 
are calendar year taxpayers. Under the agreement, L2 is credited with 
L1's reserves on the reinsured contracts on the effective date of the 
agreement, plus any new premiums received on the reinsured contracts, 
but must indemnify L1 for all claims and expenses incurred with respect 
to the contracts. Under the agreement, L1 transfers cash of $325,000 to 
L2 plus rights to its policyholder loan receivables on the reinsured 
contracts ($50,000). L2 reports the reinsurance agreement by including 
the transferred policyholder loan receivables as an asset on its books.
    (ii) For the period beginning January 1, 1994 and ending December 
31, 1994, the following income and expense items are incurred with 
respect to the reinsured contracts.

------------------------------------------------------------------------
                       Item                           Income    Expense 
------------------------------------------------------------------------
Premiums..........................................   $100,000  .........
Death benefits....................................  .........    $25,000
Surrender benefits................................  .........      5,000
Premium taxes and other expenses..................  .........      8,000
                                                              ----------
      Total.......................................  .........     38,000
------------------------------------------------------------------------

    (iii) These amounts are net of the outstanding policyholder loans 
held by L2 of $20,000 with respect to death benefits and $15,000 with 
respect to surrender benefits.
    (iv) Under paragraph (f)(8) of this section, the transferred 
policyholder loan receivables are treated as an item of consideration 
under the reinsurance agreement. In determining the parties' net 
consideration for the agreement, the transferred policyholder loan 
receivables ($50,000) are treated as an item of consideration incurred 
by L1 under paragraph (f)(2)(i)(B) of this section. Therefore, for the 
1993 taxable year, L1 has net negative consideration of ($375,000). L2 
has net positive consideration of $375,000. Under paragraph (b)(1)(ii) 
of this section, L2 includes the $375,000 net positive consideration in 
its gross amount of premiums and other consideration.
    (v) For the 1994 taxable year, L2 has net positive consideration for 
the reinsurance agreement of $62,000 before adjustment for the 
transferred policyholder loans. Under paragraph (f)(8) of this section, 
the amounts taken into account as claim and benefit payments must be 
adjusted by the amount of any transferred policyholder loan receivables 
which are netted against the reinsurer's claim and benefit 
reimbursements. Therefore, L2 takes into account $45,000 
($25,000+$20,000=$45,000) as reimbursements for death benefits, and 
$20,000 ($5,000+$15,000=$20,000) as reimbursements for surrender 
benefits. After adjustment for these items, L2 has net positive 
consideration of $27,000, which is determined by subtracting the sum of 
the amounts charged to L2 ($45,000+$20,000+$8,000=$73,000) from the sum 
of the amounts credited to L2 ($100,000). L1 has net negative 
consideration of ($27,000) under the agreement. Under paragraph 
(b)(1)(ii) of this section, L2 includes the $27,000 net positive 
consideration in its gross amount of premiums and other consideration. 
The amount of any interest earned on the policyholder loan receivables 
after their transfer to L2 is treated as investment income earned 
directly by L2, and is not taken into account as an item of 
consideration under the agreement.

    (g) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements--(1) In 
general. Paragraph (g)(3) of this section provides for a reduction in 
the amount of net negative consideration that a party to a reinsurance 
agreement (other than a reinsurance agreement described in paragraph 
(h)(2) of this section) may take into account in determining net 
premiums under paragraph (a)(2)(ii) of this section if the party with 
net positive consideration has a capitalization shortfall (as defined in 
paragraph (g)(4) of this section). Unless the party with net negative 
consideration demonstrates that the party with net positive 
consideration does not have a capitalization shortfall or demonstrates 
the amount of the other party's capitalization shortfall which is 
allocable to the reinsurance agreement, the net negative consideration 
that may be taken into account under paragraph (a)(2)(ii) of

[[Page 667]]

this section is zero. However, the reduction of paragraph (g)(3) of this 
section does not apply to a reinsurance agreement if the parties make a 
joint election under paragraph (g)(8) of this section. Under the 
election, the party with net positive consideration capitalizes 
specified policy acquisition expenses with respect to the agreement 
without regard to the general deductions limitation of section 
848(c)(1).
    (2) Application to reinsurance agreements subject to the interim 
rules. In applying this paragraph (g) to a reinsurance agreement that is 
subject to the interim rules of Sec. 1.848-3, the term ``premiums and 
other consideration incurred for reinsurance under section 
848(d)(1)(B)'' is substituted for ``net negative consideration,'' and 
the term ``gross amount of premiums and other consideration under 
section 848(d)(1)(A)'' is substituted for ``net positive 
consideration.'' If an insurance company has ``premiums and other 
consideration incurred for reinsurance under section 848(d)(1)(B)'' and 
a ``gross amount of premiums and other consideration under section 
848(d)(1)(A)'' for the same agreement, the net of these amounts is taken 
into account for purposes of this paragraph (g).
    (3) Amount of reduction. The reduction required by this paragraph 
(g)(3) equals the amount obtained by dividing--
    (i) The portion of the capitalization shortfall (as defined in 
paragraph (g)(4) of this section) allocated to the reinsurance agreement 
under paragraph (g)(7) of this section; by
    (ii) The applicable percentage set forth in section 848(c)(1) for 
the category of specified insurance contracts reinsured by the 
agreement.
    (4) Capitalization shortfall. A ``capitalization shortfall'' equals 
the excess of--
    (i) The sum of the required capitalization amounts (as defined in 
paragraph (g)(5) of this section) for all reinsurance agreements (other 
than reinsurance agreements for which an election has been made under 
paragraph (h)(3) of this section); over
    (ii) The general deductions allocated to those reinsurance 
agreements, as determined under paragraph (g)(6) of this section.
    (5) Required capitalization amount--(i) In general. The ``required 
capitalization amount'' for a reinsurance agreement (other than a 
reinsurance agreement for which an election has been made under 
paragraph (h)(3) of this section) equals the amount (either positive or 
negative) obtained by multiplying--
    (A) The net positive or negative consideration for an agreement not 
described in paragraph (h)(2) of this section, and the net positive 
consideration for an agreement described in paragraph (h)(2) of this 
section, but for which an election under paragraph (h)(3) of this 
section has not been made; by
    (B) The applicable percentage set forth in section 848(c)(1) for 
that category of specified insurance contracts.
    (ii) Special rule with respect to net negative consideration. Solely 
for purposes of computing a party's required capitalization amount under 
this paragraph (g)(5)--
    (A) If either party to the reinsurance agreement is the direct 
issuer of the reinsured contracts, the party computing its required 
capitalization amount takes into account the full amount of any net 
negative consideration without regard to any potential reduction under 
paragraph (g)(3) of this section; and
    (B) If neither party to the reinsurance agreement is the direct 
issuer of the reinsured contracts, any net negative consideration is 
deemed to equal zero in computing a party's required capitalization 
amount except to the extent that the party with the net negative 
consideration establishes that the other party to that reinsurance 
agreement capitalizes the appropriate amount.
    (6) General deductions allocable to reinsurance agreements. An 
insurance company's general deductions allocable to its reinsurance 
agreements equals the excess, if any, of--
    (i) The company's general deductions (excluding additional amounts 
treated as general deductions under paragraph (g)(8) of this section); 
over
    (ii) The amount determined under section 848(c)(1) on specified 
insurance contracts that the insurance company has issued directly 
(determined without regard to any reinsurance agreements).

[[Page 668]]

    (7) Allocation of capitalization shortfall among reinsurance 
agreements. The capitalization shortfall is allocated to each 
reinsurance agreement for which the required capitalization amount (as 
determined in paragraph (g)(5) of this section) is a positive amount. 
The portion of the capitalization shortfall allocable to each agreement 
equals the amount which bears the same ratio to the capitalization 
shortfall as the required capitalization amount for the reinsurance 
agreement bears to the sum of the positive required capitalization 
amounts.
    (8) Election to determine specified policy acquisition expenses for 
an agreement without regard to general deductions limitation--(i) In 
general. The reduction specified by paragraph (g)(3) of this section 
does not apply if the parties to a reinsurance agreement make an 
election under this paragraph (g)(8). The election requires the party 
with net positive consideration to capitalize specified policy 
acquisition expenses with respect to the reinsurance agreement without 
regard to the general deductions limitation of section 848(c)(1). That 
party must reduce its deductions under section 805 or section 832(c) by 
the amount, if any, of the party's capitalization shortfall allocable to 
the reinsurance agreement. The additional capitalized amounts are 
treated as specified policy acquisition expenses attributable to 
premiums and other consideration on the reinsurance agreement, and are 
deductible in accordance with section 848(a)(2).
    (ii) Manner of making election. To make an election under paragraph 
(g)(8) of this section, the ceding company and the reinsurer must 
include an election statement in the reinsurance agreement, either as 
part of the original terms of the agreement or by an addendum to the 
agreement. The parties must each attach a schedule to their federal 
income tax returns which identifies the reinsurance agreement for which 
the joint election under this paragraph (g)(8) has been made. The 
schedule must be attached to each of the parties' federal income tax 
returns filed for the later of--
    (A) The first taxable year ending after the election becomes 
effective; or
    (B) The first taxable year ending on or after December 29, 1992.
    (iii) Election statement. The election statement in the reinsurance 
agreement must--
    (A) Provide that the party with net positive consideration for the 
reinsurance agreement for each taxable year will capitalize specified 
policy acquisition expenses with respect to the reinsurance agreement 
without regard to the general deductions limitation of section 
848(a)(1);
    (B) Set forth the agreement of the parties to exchange information 
pertaining to the amount of net consideration under the reinsurance 
agreement each year to ensure consistency;
    (C) Specify the first taxable year for which the election is 
effective; and
    (D) Be signed by both parties.
    (iv) Effect of election. An election under this paragraph (g)(8) is 
effective for the first taxable year specified in the election statement 
and for all subsequent taxable years for which the reinsurance agreement 
remains in effect. The election may not be revoked without the consent 
of the Commissioner.
    (9) Example. The principles of this paragraph (g) are illustrated by 
the following examples.

    Example 1. (i) On December 31, 1992, a life insurance company (L1) 
transfers a block of individual life insurance contracts to an unrelated 
life insurance company (L2) under an agreement in which L2 becomes 
solely liable to the policyholders on the reinsured contracts. L1 
transfers $105,000 to L2 as consideration for the reinsurance of the 
contracts.
    (ii) L1 and L2 do not make an election under paragraph (g)(8) of 
this section to capitalize specified policy acquisition expenses with 
respect to the reinsurance agreement without regard to the general 
deductions limitation. L2 has no other insurance business, and its 
general deductions for the taxable year are $3,500.
    (iii) Under paragraph (f)(2) of this section, L1's net negative 
consideration is ($105,000). Under paragraph (f)(3) of this section, 
L2's net positive consideration is $105,000. Pursuant to paragraph 
(b)(1)(ii) of this section, L2 includes the net positive consideration 
in its gross amount of premiums and other consideration.
    (iv) The required capitalization amount under paragraph (g)(5) of 
this section for the reinsurance agreement is $8,085 ($105,000  x  
.077). L2's general deductions, all of which are allocable to the 
reinsurance agreement

[[Page 669]]

with L1, are $3,500. The $4,585 difference between the required 
capitalization amount ($8,085) and the general deductions allocable to 
the reinsurance agreement ($3,500) represents L2's capitalization 
shortfall under paragraph (g)(4) of this section.
    (v) Since L2 has a capitalization shortfall allocable to the 
agreement, the rules of paragraph (g)(1) of this section apply for 
purposes of determining the amount by which L1 may reduce its net 
premiums. Under paragraph (g)(3) of this section, L1 must reduce the 
amount of net negative consideration that it takes into account under 
paragraph (a)(2)(ii) of this section by $59,545 ($4,585/.077). Thus, of 
the $105,000 net negative consideration under the reinsurance agreement, 
L1 may take into account only $45,455 as a reduction of its net 
premiums.
    Example 2. The facts are the same as Example 1, except that L1 and 
L2 make the election under paragraph (g)(8) of this section to 
capitalize specified policy acquisition expenses with respect to the 
reinsurance agreement without regard to the general deductions 
limitation. Pursuant to this election, L2 must capitalize as specified 
policy acquisition expenses an amount equal to $8,085 ($105,000  x  
.077). L1 may reduce its net premiums by the $105,000 of net negative 
consideration.
    Example 3. (i) A life insurance company (L1) is both a direct issuer 
and a reinsurer of life insurance and annuity contracts. For 1993, L1's 
net premiums under section 848 (d)(1) for directly issued individual 
life insurance and annuity contracts are as follows:

------------------------------------------------------------------------
                        Category                           Net premiums 
------------------------------------------------------------------------
Life insurance contracts................................     $17,000,000
Annuity contracts.......................................       8,000,000
------------------------------------------------------------------------


    (ii) L1's general deductions for 1993 are $1,500,000.
    (iii) For 1993, L1 is a reinsurer under four separate indemnity 
reinsurance agreements with unrelated insurance companies (L2, L3, L4, 
and L5). The agreements with L2, L3, and L4 cover life insurance 
contracts issued by those companies. The agreement with L5 covers 
annuity contracts issued by L5, The parties to the reinsurance 
agreements have not made the election under paragraph (g)(8) of this 
section to capitalize specified policy acquisition expenses with respect 
to these agreements without regard to the general deductions limitation.
    (iv) L1's net consideration for 1993 with respect to its reinsurance 
agreements is as follows:

------------------------------------------------------------------------
                                                                Net     
                        Agreement                          consideration
------------------------------------------------------------------------
L2.......................................................    $1,200,000 
L3.......................................................      (350,000)
L4.......................................................       300,000 
L5.......................................................       600,000 
------------------------------------------------------------------------

    (v) To determine whether a reduction under paragraph (g)(3) of this 
section applies with respect to these reinsurance agreements, L1 must 
determine the required capitalization amounts for its reinsurance 
agreements and the amount of its general deductions allocable to these 
agreements.
    (vi) Pursuant to paragraph (g)(5) of this section, the required 
capitalization amount for each reinsurance agreement is determined as 
follows:

                                                                      L2
        ...............................................$1,200,000 x .077=$92,400

                                                                      L3
        .............................................($350,000) x .077=($26,950)

                                                                      L4
        .................................................$300,000 x .077=$23,100

                                                                      L5
        ................................................$600,000 x .0175=$10,500


    (vii) Thus, the sum of L1's required capitalization amounts on its 
reinsurance agreements equals $99,050.
    (viii) Pursuant to paragraph (g)(6) of this section, L1 determines 
its general deductions allocable to its reinsurance agreements. The 
amount determined under section 848(c)(1) on its directly issued 
contracts is:

                                                                        
                                                                        
                                                                        
Category:                                                               
  Annuity contracts...................  $8,000,000 x .0175 =    $140,000
  Life insurance contracts............  $17,000,000 x .077 =   1,309,000
                                                             -----------
                                                              $1,449,000
                                                                        


    (ix) L1's general deductions allocable to its reinsurance agreements 
are $51,000 ($1,500,000-$1,449,000).
    (x) Pursuant to paragraph (g)(4) of this section, L1's 
capitalization shortfall equals $48,050, reflecting the excess of L1's 
required capitalization amounts for its reinsurance agreements ($99,050) 
over the general deductions allocable to its reinsurance agreements 
($51,000).
    (xi) Pursuant to paragraph (g)(7) of this section, the 
capitalization shortfall of $48,050 must be allocated between each of 
L1's reinsurance agreements with net positive consideration in 
proportion to their respective required capitalization amounts. The 
allocation of the shortfall between L1's reinsurance agreements is 
determined as follows:

L2=$35,237 ($48,050 x 92,400/126,000)
L4=$8,809 ($48,050 x 23,100/126,000)
L5=$4,004 ($48,050 x 10,500/126,000)

    (xii) Accordingly, the reduction under paragraph (g)(3) of this 
section that applies to the amount of net negative consideration that 
may be taken into account by L2, L4, and L5 under paragraph 
(a)(1)(ii)(B) of this section is determined as follows:

L2=$457,623 ($35,237/.077)

[[Page 670]]

L4=$114,403 ($8,809/.077)
L5=$228,800 ($4,004/.0175)

    Example 4. The facts are the same as Example 3, except that L1 and 
L4 make a joint election under paragraph (g)(8) of this section to 
capitalize specified policy acquisition expenses with respect to the 
reinsurance agreement without regard to the general deductions 
limitation. Pursuant to this election, L1 must reduce its deductions 
under section 805 by an amount equal to the capitalization shortfall 
allocable to the reinsurance agreement with L4 ($8,809). L1 treats the 
additional capitalized amounts as specified policy acquisition expenses 
allocable to premiums and other consideration under the agreement. L4 
may reduce its net premiums by the $300,000 net negative consideration. 
The election by L1 and L4 does not change the amount of the 
capitalization shortfall allocable under paragraph (g)(7) of this 
section to the reinsurance agreements with L2 and L5. Thus, the 
reduction required by paragraph (g)(3) of this section with respect to 
the amount of the net negative consideration that L2 and L5 may 
recognize under paragraph (a)(2)(ii) of this section is $457,623 and 
$228,800, respectively.

    (h) Treatment of reinsurance agreements with parties not subject to 
U.S. taxation--(1) In general. Unless an election under paragraph (h)(3) 
of this section is made, an insurance company may not reduce its net 
premiums by the net negative consideration for the taxable year (or, 
with respect to a reinsurance agreement that is subject to the interim 
rules of Sec. 1.848-3, by the premiums and other consideration incurred 
for reinsurance) under a reinsurance agreement to which this paragraph 
(h) applies.
    (2) Agreements to which this paragraph (h) applies--(i) In general. 
This paragraph (h) applies to a reinsurance agreement if, with respect 
to the premiums and other consideration under the agreement, one party 
to that agreement is subject to United States taxation and the other 
party is not.
    (ii) Parties subject to U.S. taxation--(A) In general. A party is 
subject to United States taxation for this purpose if the party is 
subject to United States taxation either directly under the provisions 
of subchapter L of chapter 1 of the Internal Revenue Code (subchapter 
L), or indirectly under the provisions of subpart F of part III of 
subchapter N of chapter 1 of the Internal Revenue Code (subpart F).
    (B) Effect of a closing agreement. If a reinsurer agrees in a 
closing agreement with the Internal Revenue Service to be subject to tax 
under rules equivalent to the provisions of subchapter L on its premiums 
and other consideration from reinsurance agreements with parties subject 
to United States taxation, the reinsurer is treated as an insurance 
company subject to tax under subchapter L.
    (3) Election to separately determine the amounts required to be 
capitalized for reinsurance agreements with parties not subject to U.S. 
taxation--(i) In general. This paragraph (h)(3) authorizes an insurance 
company to make an election to separately determine the amounts required 
to be capitalized for the taxable year with respect to reinsurance 
agreements with parties that are not subject to United States taxation. 
If this election is made, an insurance company separately determines a 
net foreign capitalization amount for the taxable year for all 
reinsurance agreements to which this paragraph (h) applies.
    (ii) Manner of making the election. An insurance company makes the 
election authorized by this paragraph (h)(3) by attaching an election 
statement to the federal income tax return (including an amended return) 
for the taxable year for which the election becomes effective. The 
election applies to that taxable year and all subsequent taxable years 
unless permission to revoke the election is obtained from the 
Commissioner.
    (4) Amount taken into account for purposes of determining specified 
policy acquisition expenses. If for a taxable year an insurance company 
has a net positive foreign capitalization amount (as defined in 
paragraph (h)(5)(i) of this section), any portion of that amount 
remaining after the reduction described in paragraph (h)(7) of this 
section is treated as additional specified policy acquisition expenses 
for the taxable year (determined without regard to amounts taken into 
account under this paragraph (h)). A net positive capitalization amount 
is treated as an amount otherwise required to be capitalized for the 
taxable year for purposes of the reduction under section 848(f)(1)(A).

[[Page 671]]

    (5) Net foreign capitalization amount--(i) In general. An insurance 
company's net foreign capitalization amount equals the sum of the 
foreign capitalization amounts (netting positive and negative amounts) 
determined under paragraph (h)(5)(ii) of this section for each category 
of specified insurance contracts reinsured by agreements described in 
paragraph (h)(2) of this section. If the amount is less than zero, the 
company has a net negative foreign capitalization amount. If the amount 
is greater than zero, the company has a net positive foreign 
capitalization amount.
    (ii) Foreign capitalization amounts by category. The foreign 
capitalization amount for a category of specified insurance contracts is 
determined by--
    (A) Combining the net positive consideration and the net negative 
consideration for the taxable year (or, with respect to a reinsurance 
agreement that is subject to the interim rules of Sec. 1.848-3, by 
combining the gross amount of premiums and other consideration and the 
premiums and other consideration incurred for reinsurance) for all 
agreements described in paragraph (h)(2) of this section which reinsure 
specified insurance contracts in that category; and
    (B) Multiplying the result (either positive or negative) by the 
percentage for that category specified in section 848(c)(1).
    (6) Treatment of net negative foreign capitalization amount--(i) 
Applied as a reduction to previously capitalized amounts. If for a 
taxable year an insurance company has a net negative foreign 
capitalization amount, the negative amount reduces (but not below zero) 
the unamortized balances of the amounts previously capitalized 
(beginning with the amount capitalized for the most recent taxable year) 
to the extent attributable to prior years' net positive foreign 
capitalization amounts. The amount by which previously capitalized 
amounts is reduced is allowed as a deduction for the taxable year.
    (ii) Carryover of remaining net negative foreign capitalization 
amount. The net negative foreign capitalization amount, if any, 
remaining after the reduction described in paragraph (h)(6)(i) of this 
section is carried over to reduce a future net positive capitalization 
amount. The remaining net negative foreign capitalization amount may 
only offset a net positive foreign capitalization amount in a future 
year, and may not be used to reduce the amounts otherwise required to be 
capitalized under section 848(a) for the taxable year, or to reduce the 
unamortized balances of specified policy acquisition expenses from 
preceding taxable years, with respect to directly written business or 
reinsurance agreements other than agreements for which the election 
under paragraph (h)(3) of this section has been made.
    (7) Reduction of net positive foreign capitalization amount by 
carryover amounts allowed. If for a taxable year an insurance company 
has a net positive foreign capitalization amount, that amount is reduced 
(but not below zero) by any carryover of net negative foreign 
capitalization amounts from preceding taxable years. Any remaining net 
positive foreign capitalization amount is taken into account as provided 
in paragraph (h)(4) of this section.
    (8) Examples. The principles of this paragraph (h) are illustrated 
by the following examples.

    Example 1. (i) On January 1, 1993, a life insurance company (L1) 
enters into a reinsurance agreement with a foreign corporation (X) 
covering a block of annuity contracts issued to residents of the United 
States. X is not subject to taxation either directly under subchapter L 
or indirectly under subpart F on the premiums for the reinsurance 
agreement with L1. L1 makes the election under paragraph (h)(3) of this 
section to separately determine the amounts required to be capitalized 
for the taxable year with respect to parties not subject to United 
States taxation.
    (ii) For the taxable year ended December 31, 1993, L1 has net 
negative consideration of ($25,000) under its reinsurance agreement with 
X. L1 has no other reinsurance agreements with parties not subject to 
United States taxation.
    (iii) Under paragraph (h)(5) of this section, L1's net negative 
foreign capitalization amount for the 1993 taxable year equals 
($437.50), which is determined by multiplying L1's net negative 
consideration on the agreement with X ($25,000) by the percentage in 
section 848(c)(1) for the reinsured specified insurance contracts 
(1.75%). Under paragraph (h)(6)(ii) of this section, L1 carries over the

[[Page 672]]

net negative foreign capitalization amount of $437.50) to future taxable 
years. The net negative foreign capitalization amount may not be used to 
reduce the amounts which L1 is required to capitalize on directly 
written business or reinsurance agreements other than those agreements 
described in paragraph (h)(2) of this section.
    Example 2. (i) The facts are the same as Example 1 except that L1 
terminates its reinsurance agreement with X and receives $35,000 on 
December 31, 1994. For the 1994 taxable year, L1 has net positive 
consideration of $35,000 under its agreement with X. L1 has no other 
reinsurance agreements with parties not subject to United States 
taxation.
    (ii) Under paragraph (h)(5) of this section, L1's net positive net 
foreign capitalization amount for the 1984 taxable year equals $612.50, 
which is determined by multiplying the net positive consideration on the 
agreement with X ($35,000) by the percentage in section 848(c)(1) for 
the reinsured specified insurance contracts (1.75%). Under paragraph 
(h)(4) of this section, L1 reduces the net positive foreign 
capitalization amount for the taxable year by the net negative foreign 
capitalization amount carried over from preceding taxable years 
($437.50). After this reduction, L1 includes $175 ($612.50-$437.50) as 
specified policy acquisition expenses for the 1994 taxable year.

    (i) Carryover of excess negative capitalization amount--(1) In 
general. This paragraph (i) authorizes a carryover of an excess negative 
capitalization amount (as defined in paragraph (i)(2) of this section) 
to reduce amounts otherwise required to be capitalized under section 
848. Paragraph (i)(4) provides special rules for the treatment of excess 
negative capitalization amounts of insolvent insurance companies.
    (2) Excess negative capitalization amount. The excess negative 
capitalization amount with respect to a category of specified insurance 
contracts for a taxable year is equal to the excess of--
    (A) The negative capitalization amount with respect to that 
category; over
    (B) The amount that can be utilized under section 848(f)(1).
    (3) Treatment of excess negative capitalization amount. The excess 
negative capitalization amount for a taxable year reduces the amounts 
that are otherwise required to be capitalized by an insurance company 
under section 848(c)(1) for future years.
    (4) Special rule for the treatment of an excess negative 
capitalization amount of an insolvent company--(i) When applicable. This 
paragraph (i)(4) applies only for the taxable year in which an insolvent 
insurance company has an excess negative capitalization amount and has 
net negative consideration under a reinsurance agreement. See paragraph 
(i)(4)(v) of this section for the definition of ``insolvent.''
    (ii) Election to forego carryover of excess negative capitalization 
amount. At the joint election of the insolvent insurance company and the 
other party to the reinsurance agreement--
    (A) The insolvent insurance company reduces the excess negative 
capitalization amount which would otherwise be carried over under 
paragraph (i)(1) of this section by the amount determined under 
paragraph (i)(4)(iii) of this section; and
    (B) The other party reduces the amount of its specified policy 
acquisition expenses for the taxable year by the amount determined under 
paragraph (i)(4)(iii) of this section.
    (iii) Amount of reduction to the excess negative capitalization 
amount and specified policy acquisition expenses. To determine the 
reduction to the carryover of an insolvent insurance company's excess 
negative capitalization amount and the specified policy acquisition 
expenses of the other party with respect to a reinsurance agreement--
    (A) Multiply the net negative consideration for each reinsurance 
agreement of the insolvent insurer for which there is net negative 
consideration for the taxable year by the appropriate percentage 
specified in section 848(c)(1) for the category of specified insurance 
contracts reinsured by the agreement;
    (B) Sum the results for each agreement;
    (C) Calculate the ratio between the results in paragraphs 
(i)(4)(iii) (A) and (B) of this section for each agreement; and
    (D) Multiply that result by the increase in the excess negative 
capitalization amount of the insolvent insurer for the taxable year.
    (iv) Manner of making election. To make an election under paragraph 
(i)(4) of this section, each party to the reinsurance agreement must 
attach an election statement to its federal income tax return (including 
an amended

[[Page 673]]

return) for the taxable year for which the election is effective. The 
election statement must identify the reinsurance agreement for which the 
joint election under this paragraph (i)(4) has been made, state the 
amount of the reduction to the insolvent insurance company's excess 
negative capitalization amount that is attributable to the agreement, 
and be signed by both parties. An election under this paragraph (i)(4) 
is effective for the taxable year specified in the election statement, 
and may not be revoked without the consent of the Commissioner.
    (v) Presumptions relating to the insolvency of an insurance company 
undergoing a court supervised rehabilitation or similar state 
proceeding. For purposes of this paragraph (i)(4), an insurance company 
which is undergoing a rehabilitation, conservatorship, or similar state 
proceeding shall be presumed to be insolvent if the state proceeding 
results in--
    (A) An order of the state court finding that the fair market value 
of the insurance company's assets is less than its liabilities;
    (B) The use of funds, guarantees, or reinsurance from a guaranty 
association;
    (C) A reduction of the policyholders' available account balances; or
    (D) A substantial limitation on access to funds (for example, a 
partial or total moratorium on policyholder withdrawals or surrenders 
that applies for a period of 5 years).
    (vi) Example. The principles of this paragraph (i)(4) are 
illustrated by the following example.

    Example. (i) An insurance company (L1) is the subject of a 
rehabilitation proceeding under the supervision of a state court. The 
state court has made a finding that the fair market value of L1's assets 
is less than its liabilities. On December 31, 1993, L1 transfers a block 
of individual life insurance contracts to an unrelated insurance company 
(L2) under an assumption reinsurance agreement whereby L2 becomes solely 
liable to the policyholders under the contracts reinsured. Under the 
agreement, L1 agrees to pay L2 $2,000,000 for assuming the life 
insurance contracts. This negative net consideration causes L1 to incur 
an excess negative capitalization amount of $138,600 for the 1993 
taxable year. L1 has no other reinsurance agreements for the taxable 
year.
    (ii) As part of the reinsurance agreement, L1 and L2 agree to make 
an election under paragraph (i)(4) of this section. Under the election, 
L1 agrees to forgo the carryover of the $138,600 excess negative 
capitalization amount for future taxable years. L2 must include the 
$2,000,000 net positive consideration for the reinsurance agreement in 
its gross amount of premiums and other consideration. L2 reduces its 
specified policy acquisition expenses for the 1993 taxable year by 
$138,600.

    (j) Ceding commissions with respect to reinsurance of contracts 
other than specified insurance contracts. A ceding commission incurred 
with respect to the reinsurance of an insurance contract that is not a 
specified insurance contract is not subject to the provisions of section 
848(g).
    (k) Effective dates--(1) In general. Unless otherwise specified in 
this paragraph, the rules of this section are effective for the taxable 
years of an insurance company beginning after November 14, 1991.
    (2) Reduction in the amount of net negative consideration to ensure 
consistency of capitalization for reinsurance agreements. Section 1.848-
2(g) (which provides for an adjustment to ensure consistency) is 
effective for--
    (i) All amounts arising under any reinsurance agreement entered into 
after November 14, 1991; and
    (ii) All amounts arising under any reinsurance agreement for taxable 
years beginning after December 31, 1991, without regard to the date on 
which the reinsurance agreement was entered into.
    (3) Net consideration rules. Section 1.848-2(f) (which provides 
rules for determining the net consideration for a reinsurance agreement) 
applies to--
    (i) Amounts arising in taxable years beginning after December 31, 
1991, under a reinsurance agreement entered into after November 14, 
1991; and
    (ii) Amounts arising in taxable years beginning after December 31, 
1994, under a reinsurance agreement entered into before November 15, 
1991.
    (4) Determination of the date on which a reinsurance agreement is 
entered into. A reinsurance agreement is considered entered into at the 
earlier of--
    (i) The date of the reinsurance agreement; or

[[Page 674]]

    (ii) The date of a binding written agreement to enter into a 
reinsurance transaction if the written agreement evidences the parties' 
agreement on substantially all material items relating to the 
reinsurance transaction.
    (5) Special rule for certain reinsurance agreements with parties not 
subject to U.S. taxation. The election and special rules in paragraph 
(h) of this section relating to the determination of amounts required to 
be capitalized on reinsurance agreements with parties not subject to 
United States taxation apply to taxable years ending on or after 
September 30, 1990.
    (6) Carryover of excess negative capitalization amount. The 
provisions of paragraph (i) of this section, including the special rule 
for the treatment of excess negative capitalization amounts of insolvent 
insurance companies, are affected with respect to amounts arising in 
taxable years ending on or after September 30, 1990.

[T.D. 8456, 57 FR 61821, Dec. 29, 1992; 58 FR 7987, Feb. 11, 1993; 59 FR 
947, Jan. 7, 1994]



Sec. 1.848-3  Interim rules for certain reinsurance agreements.

    (a) Scope and effective dates. The rules of this section apply in 
determining net premiums for a reinsurance agreement with respect to--
    (1) Amounts arising in taxable years beginning before January 1, 
1992, under a reinsurance agreement entered into after November 14, 
1991; and
    (2) Amounts arising in taxable years beginning before January 1, 
1995, under a reinsurance agreement entered into before November 15, 
1991.
    (b) Interim rules. In determining a company's gross amount of 
premiums and other consideration under section 848(d)(1)(A) and premiums 
and other consideration incurred for reinsurance under section 
848(d)(1)(B), the general rules of subchapter L of the Internal Revenue 
Code apply with the adjustments and special rules set forth in paragraph 
(c) of this section. Except as provided in paragraph (c)(5) of this 
section (which applies to modified coinsurance transactions), the gross 
amount of premiums and other consideration is determined without any 
reduction for ceding commissions, annual allowances, reimbursements of 
claims and benefits, or other amounts incurred by a reinsurer with 
respect to reinsured contracts.
    (c) Adjustment and special rules. This paragraph sets forth certain 
adjustments and special rules that apply for reinsurance agreements in 
determining the gross amount of premiums and other consideration under 
section 848(d)(1)(A) and premiums and other considerations incurred for 
reinsurance under section 848(d)(1)(B).
    (1) Assumption reinsurance. The ceding company must treat the gross 
amount of consideration incurred with respect to an assumption 
reinsurance agreement as premiums and other consideration incurred for 
reinsurance under section 848(d)(1)(B). The reinsurance must include the 
same amount in the gross amount of premiums and other consideration 
under section 848(d)(1)(A). For rules relating to the determination and 
treatment of ceding commissions, see paragraph (c)(3) of this section.
    (2) Reimbursable dividends. The reinsurer must treat the amount of 
policyholder dividends reimbursable to the ceding company (other than 
under a modified coinsurance agreement covered by paragraph (c)(5) of 
this section) as a return premium under section 848(d)(1)(B). The ceding 
company must include the same amount in the gross amount of premiums and 
other consideration under section 848(d)(1)(A). The amount of any 
experience-related refund due the ceding company is treated as a 
policyholder dividend reimbursable to the ceding company.
    (3) Ceding commissions--(i) In general. The reinsurer must treat 
ceding commissions as a general deduction. The ceding company must treat 
ceding commissions as non-premium related income under section 
803(a)(3). The ceding company may not reduce its general deductions by 
the amount of the ceding commission.
    (ii) Amount of ceding commission. For purposes of this section, the 
amount of a ceding commission equals the excess, if any, of--
    (A) The increase in the reinsurer's tax reserves resulting from the 
reinsurance agreement (computed in accordance with section 807(d)); over

[[Page 675]]

    (B) The gross consideration incurred by the ceding company for the 
reinsurance agreement, less any amount incurred by the reinsurer as part 
of the reinsurance agreement.
    (4) Termination payments. The reinsurer must treat the gross amount 
of premiums and other consideration payable as a termination payment to 
the ceding company (including the tax reserves on the reinsured 
contracts) as premiums and other consideration incurred for reinsurance 
under section 848(d)(1)(B). The ceding company must include the same 
amount in the gross amount of premiums and other consideration under 
section 848(d)(1)(A). This paragraph does not apply to modified 
coinsurance agreements.
    (5) Modified coinsurance agreements. In the case of a modified 
coinsurance agreement, the parties must determine their net premiums on 
a net consideration basis as described in Sec. 1.848-2(f)(5).
    (D) Examples. The principles of this section are illustrated by the 
following examples.

    Example 1. On July 1, 1991, an insurance company (L1) transfers a 
block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policy holder under the contracts reinsured. The tax reserves on the 
reinsured contracts are $100,000. Under the assumption reinsurance 
agreement, L1 pays L2 $83,000 for assuming the life insurance contracts. 
Under paragraph (c)(3) of this section, since the increase in L2's tax 
reserves ($100,000) exceeds the net consideration transferred by L1 
($83,000), the reinsurance agreement provides for a ceding commission. 
The ceding commission equals $17,000 ($100,000-$83,000). Under paragraph 
(c)(3) of this section, L1 reduces its gross amount of premiums and 
other consideration for the 1991 taxable year under section 848(d)(1)(B) 
by the $100,000 premium incurred for reinsurance, and L2 includes the 
$100,000 premium for reinsurance in its gross amount of premiums and 
other consideration under section 848(d)(1)(A). L1 treats the $17,000 
ceding commission as non-premium related income and section 803 (a)(3).
    Example 2. On July 1, 1991, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policyholder under the contracts reinsured. The tax reserves on the 
reinsured contracts are $100,000. Under the assumption reinsurance 
agreement, L1 pays L2 $100,000 for assuming the contracts, and L2 pays 
L1 a $17,000 ceding commission. Under paragraph (c)(1) of this section, 
L1 reduces its gross amount of premiums and other consideration under 
section 848(d)(1)(B) by $100,000. L2 includes $100,000 in its gross 
amount of premiums and other consideration under section 848(d)(1)(A). 
Under paragraph (c)(3) of this section, since the increase in L2's tax 
reserves ($100,000) exceeds the net consideration transferred by L1, the 
reinsurance agreement provides for a ceding commission. The ceding 
commission equals $17,000 ($100,000 increase in L2's tax reserves less 
$83,000 net consideration transferred by L1). L1 treats the $17,000 
ceding commission as non-premium related income under section 803(a)(3).
    Example 3. On July 1, 1991, a life insurance company (L1) transfers 
a block of individual life insurance contracts to an unrelated insurance 
company (L2) under an arrangement whereby L2 becomes solely liable to 
the policyholder under the contracts reinsured. Under the assumption 
reinsurance agreement, L1 transfers assets of $105,000 to L2. The tax 
reserves on the reinsured contracts are $100,000. Under paragraph (c)(1) 
of this section, L1 reduces its gross amount of premiums and other 
consideration under section 848(d)(1)(B) by $105,000, and L2 increases 
its gross amount of premiums and other consideration under section 
848(d)(1)(A) by $105,000. Since the net consideration transferred by L1 
exceeds the increase in L2's tax reserves, there is no ceding commission 
under paragraph (c)(3) of this section.
    Example 4. (i) On June 30, 1991, a life insurance company (L1) 
reinsures 40% of certain individual life insurance contracts to be 
issued after that date with an unrelated insurance company (L2) under an 
agreement whereby L1 remains directly liable to the policyholders with 
respect to the contracts reinsured. The agreement provides that L2 is 
credited with 40% of any premiums received with respect to the reinsured 
contracts, but must indemnify L1 for 40% of any claims, expenses, and 
policyholder dividends. During the period from July 1 through December 
31, 1991, L1 has the following income and expense items with respect to 
the reinsured policies:

------------------------------------------------------------------------
                         Item                           Income   Expense
------------------------------------------------------------------------
Premiums.............................................   $8,000  ........
Benefits paid........................................  .......    $1,000
Commissions..........................................  .......     6,000
Policyholder dividends...............................  .......       500
                                                      ----------        
      Total..........................................  .......     7,500
------------------------------------------------------------------------


    (ii) Under paragraphs (b) and (c)(2) of this section, L1 includes 
$8,200 in its gross amount of premiums and other consideration under 
section 848(d)(1)(A) ($8,000 gross premiums on the reinsured contracts 
plus $200 of policyholder dividends reimbursed by L2

[[Page 676]]

($500  x  40%). L1 reduces its gross amount of premiums and other 
consideration by $3,200 (40%  x  $8,000) as premiums and other 
consideration incurred for reinsurance under section 848(d)(1)(B). The 
benefits and commissions incurred by L1 with respect to the reinsured 
contracts do not reduce L1's gross amount of premiums and other 
consideration under section 848(d)(1)(B). L2 includes $3,200 in its 
gross amount of premiums and other consideration (40%  x  $8,000) and is 
treated as having paid return premiums of $200 (the amount of 
reimbursable dividends paid to L1). L2 is also treated as having 
incurred the following expenses with respect to the reinsured contracts: 
$400 as benefits paid (40%  x  $1,000) and $2,400 as commissions expense 
(40%  x  $6,000). Under paragraph (b) of this section, these expenses do 
not reduce L2's gross amount of premiums and other consideration under 
section 848(d)(1)(A).
    Example 5. On December 31, 1991, an insurance company (L1) 
terminates a reinsurance agreement with an unrelated insurance company 
(L2). The termination applies to a reinsurance agreement under which L1 
had ceded 40% of its liability on a block of individual life insurance 
contracts to L2. Upon termination of the reinsurance agreement, L2 makes 
a final payment of $116,000 to L1 for assuming full liability under the 
contracts. The tax reserves attributable to L2's portion of the 
reinsured contracts are $120,000. Under paragraph (c)(4) of this 
section, L2 reduces its gross amount of premiums and other consideration 
under section 848(d)(1)(B) by $120,000. L1 includes $120,000 in its 
gross amount of premiums and other consideration under section 
848(d)(1)(A).
    Example 6. (i) On June 30, 1991, an insurance company (L1) reinsures 
40% of its existing life insurance contracts with an unrelated life 
insurance company (L2) under a modified coinsurance agreement. For the 
period July 1, 1991 through December 31, 1991, L1 reports the following 
income and expense items with respect to L2's 40% share of the reinsured 
contracts:

------------------------------------------------------------------------
                        Item                           Income    Expense
------------------------------------------------------------------------
Premiums............................................   $10,000          
Benefits paid.......................................  ........    $4,000
Policyholder dividends..............................  ........       500
Reserve adjustment..................................  ........     1,500
                                                               ---------
      Total.........................................  ........     6,000
------------------------------------------------------------------------

    (ii) Pursuant to paragraph (c)(5) of this section, L1 reduces its 
gross amount of premiums and other consideration under section 
848(d)(1)(B) by the $4,000 net consideration for the modified 
coinsurance agreement ($10,000-$6,000). L2 includes the $4,000 net 
consideration in its gross amount of premiums and other consideration 
under section 848(d)(1)(A).

[T.D. 8456, 57 FR 61829, Dec. 29, 1992]
[[Page 677]]



                              FINDING AIDS




  --------------------------------------------------------------------

  A list of CFR titles, subtitles, chapters, subchapters and parts and 
an alphabetical list of agencies publishing in the CFR are included in 
the CFR Index and Finding Aids volume to the Code of Federal Regulations 
which is published separately and revised annually.

  Table of CFR Titles and Chapters
  Alphabetical List of Agencies Appearing in the CFR
  Table of OMB Control Numbers
  List of CFR Sections Affected



[[Page 679]]



                    Table of CFR Titles and Chapters




                      (Revised as of April 1, 1997)

                      Title 1--General Provisions

         I  Administrative Committee of the Federal Register 
                (Parts 1--49)
        II  Office of the Federal Register (Parts 50--299)
        IV  Miscellaneous Agencies (Parts 400--500)

                          Title 2--[Reserved]

                        Title 3--The President

         I  Executive Office of the President (Parts 100--199)

                           Title 4--Accounts

         I  General Accounting Office (Parts 1--99)
        II  Federal Claims Collection Standards (General 
                Accounting Office--Department of Justice) (Parts 
                100--299)

                   Title 5--Administrative Personnel

         I  Office of Personnel Management (Parts 1--1199)
        II  Merit Systems Protection Board (Parts 1200--1299)
       III  Office of Management and Budget (Parts 1300--1399)
        IV  Advisory Committee on Federal Pay (Parts 1400--1499)
         V  The International Organizations Employees Loyalty 
                Board (Parts 1500--1599)
        VI  Federal Retirement Thrift Investment Board (Parts 
                1600--1699)
       VII  Advisory Commission on Intergovernmental Relations 
                (Parts 1700--1799)
      VIII  Office of Special Counsel (Parts 1800--1899)
        IX  Appalachian Regional Commission (Parts 1900--1999)
        XI  Armed Forces Retirement Home (Part 2100)
       XIV  Federal Labor Relations Authority, General Counsel of 
                the Federal Labor Relations Authority and Federal 
                Service Impasses Panel (Parts 2400--2499)
        XV  Office of Administration, Executive Office of the 
                President (Parts 2500--2599)
       XVI  Office of Government Ethics (Parts 2600--2699)
       XXI  Department of the Treasury (Parts 3100--3199)
      XXII  Federal Deposit Insurance Corporation (Part 3201)
     XXIII  Department of Energy (Part 3301)

[[Page 680]]

      XXIV  Federal Energy Regulatory Commission (Part 3401)
      XXVI  Department of Defense (Part 3601)
    XXVIII  Department of Justice (Part 3801)
      XXIX  Federal Communications Commission (Parts 3900--3999)
       XXX  Farm Credit System Insurance Corporation (Parts 4000--
                4099)
      XXXI  Farm Credit Administration (Parts 4100--4199)
    XXXIII  Overseas Private Investment Corporation (Part 4301)
      XXXV  Office of Personnel Management (Part 4501)
        XL  Interstate Commerce Commission (Part 5001)
       XLI  Commodity Futures Trading Commission (Part 5101)
      XLII  Department of Labor (Part 5201)
     XLIII  National Science Foundation (Part 5301)
       XLV  Department of Health and Human Services (Part 5501)
      XLVI  Postal Rate Commission (Part 5601)
     XLVII  Federal Trade Commission (Part 5701)
    XLVIII  Nuclear Regulatory Commission (Part 5801)
         L  Department of Transportation (Part 6001)
       LII  Export-Import Bank of the United States (Part 6201)
      LIII  Department of Education (Parts 6300--6399)
       LIV  Environmental Protection Agency (Part 6401)
      LVII  General Services Administration (Part 6701)
     LVIII  Board of Governors of the Federal Reserve System (Part 
                6801)
       LIX  National Aeronautics and Space Administration (Part 
                6901)
        LX  United States Postal Service (Part 7001)
       LXI  National Labor Relations Board (Part 7101)
      LXII  Equal Employment Opportunity Commission (Part 7201)
     LXIII  Inter-American Foundation (Part 7301)
       LXV  Department of Housing and Urban Development (Part 
                7501)
      LXVI  National Archives and Records Administration (Part 
                7601)
      LXIX  Tennessee Valley Authority (Part 7901)
      LXXI  Consumer Product Safety Commission (Part 8101)
     LXXIV  Federal Mine Safety and Health Review Commission (Part 
                8401)
     LXXVI  Federal Retirement Thrift Investment Board (Part 8601)
    LXXVII  Office of Management and Budget (Part 8701)

                          Title 6--[Reserved]

                         Title 7--Agriculture

            Subtitle A--Office of the Secretary of Agriculture 
                (Parts 0--26)
            Subtitle B--Regulations of the Department of 
                Agriculture
         I  Agricultural Marketing Service (Standards, 
                Inspections, Marketing Practices), Department of 
                Agriculture (Parts 27--209)
        II  Food and Consumer Service, Department of Agriculture 
                (Parts 210--299)

[[Page 681]]

       III  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 300--399)
        IV  Federal Crop Insurance Corporation, Department of 
                Agriculture (Parts 400--499)
         V  Agricultural Research Service, Department of 
                Agriculture (Parts 500--599)
        VI  Natural Resources Conservation Service, Department of 
                Agriculture (Parts 600--699)
       VII  Farm Service Agency, Department of Agriculture (Parts 
                700--799)
      VIII  Grain Inspection, Packers and Stockyards 
                Administration (Federal Grain Inspection Service), 
                Department of Agriculture (Parts 800--899)
        IX  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Fruits, Vegetables, Nuts), Department 
                of Agriculture (Parts 900--999)
         X  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Milk), Department of Agriculture 
                (Parts 1000--1199)
        XI  Agricultural Marketing Service (Marketing Agreements 
                and Orders; Miscellaneous Commodities), Department 
                of Agriculture (Parts 1200--1299)
       XIV  Commodity Credit Corporation, Department of 
                Agriculture (Parts 1400--1499)
        XV  Foreign Agricultural Service, Department of 
                Agriculture (Parts 1500--1599)
       XVI  Rural Telephone Bank, Department of Agriculture (Parts 
                1600--1699)
      XVII  Rural Utilities Service, Department of Agriculture 
                (Parts 1700--1799)
     XVIII  Rural Housing Service, Rural Business-Cooperative 
                Service, Rural Utilities Service, and Farm Service 
                Agency, Department of Agriculture (Parts 1800--
                2099)
      XXVI  Office of Inspector General, Department of Agriculture 
                (Parts 2600--2699)
     XXVII  Office of Information Resources Management, Department 
                of Agriculture (Parts 2700--2799)
    XXVIII  Office of Operations, Department of Agriculture (Parts 
                2800--2899)
      XXIX  Office of Energy, Department of Agriculture (Parts 
                2900--2999)
       XXX  Office of Finance and Management, Department of 
                Agriculture (Parts 3000--3099)
      XXXI  Office of Environmental Quality, Department of 
                Agriculture (Parts 3100--3199)
     XXXII  [Reserved]
    XXXIII  Office of Transportation, Department of Agriculture 
                (Parts 3300--3399)
     XXXIV  Cooperative State Research, Education, and Extension 
                Service, Department of Agriculture (Parts 3400--
                3499)
      XXXV  Rural Housing Service, Department of Agriculture 
                (Parts 3500--3599)

[[Page 682]]

     XXXVI  National Agricultural Statistics Service, Department 
                of Agriculture (Parts 3600--3699)
    XXXVII  Economic Research Service, Department of Agriculture 
                (Parts 3700--3799)
   XXXVIII  World Agricultural Outlook Board, Department of 
                Agriculture (Parts 3800--3899)
       XLI  [Reserved]
      XLII  Rural Business-Cooperative Service and Rural Utilities 
                Service, Department of Agriculture (Parts 4200--
                4299)

                    Title 8--Aliens and Nationality

         I  Immigration and Naturalization Service, Department of 
                Justice (Parts 1--499)

                 Title 9--Animals and Animal Products

         I  Animal and Plant Health Inspection Service, Department 
                of Agriculture (Parts 1--199)
        II  Grain Inspection, Packers and Stockyards 
                Administration (Packers and Stockyards Programs), 
                Department of Agriculture (Parts 200--299)
       III  Food Safety and Inspection Service, Meat and Poultry 
                Inspection, Department of Agriculture (Parts 300--
                599)

                           Title 10--Energy

         I  Nuclear Regulatory Commission (Parts 0--199)
        II  Department of Energy (Parts 200--699)
       III  Department of Energy (Parts 700--999)
         X  Department of Energy (General Provisions) (Parts 
                1000--1099)
        XI  United States Enrichment Corporation (Parts 1100--
                1199)
        XV  Office of the Federal Inspector for the Alaska Natural 
                Gas Transportation System (Parts 1500--1599)
      XVII  Defense Nuclear Facilities Safety Board (Parts 1700--
                1799)

                      Title 11--Federal Elections

         I  Federal Election Commission (Parts 1--9099)

                      Title 12--Banks and Banking

         I  Comptroller of the Currency, Department of the 
                Treasury (Parts 1--199)
        II  Federal Reserve System (Parts 200--299)
       III  Federal Deposit Insurance Corporation (Parts 300--399)
        IV  Export-Import Bank of the United States (Parts 400--
                499)
         V  Office of Thrift Supervision, Department of the 
                Treasury (Parts 500--599)
        VI  Farm Credit Administration (Parts 600--699)

[[Page 683]]

       VII  National Credit Union Administration (Parts 700--799)
      VIII  Federal Financing Bank (Parts 800--899)
        IX  Federal Housing Finance Board (Parts 900--999)
        XI  Federal Financial Institutions Examination Council 
                (Parts 1100--1199)
       XIV  Farm Credit System Insurance Corporation (Parts 1400--
                1499)
        XV  Thrift Depositor Protection Oversight Board (Parts 
                1500--1599)
      XVII  Office of Federal Housing Enterprise Oversight, 
                Department of Housing and Urban Development (Parts 
                1700-1799)
     XVIII  Community Development Financial Institutions Fund, 
                Department of the Treasury (Parts 1800--1899)

               Title 13--Business Credit and Assistance

         I  Small Business Administration (Parts 1--199)
       III  Economic Development Administration, Department of 
                Commerce (Parts 300--399)

                    Title 14--Aeronautics and Space

         I  Federal Aviation Administration, Department of 
                Transportation (Parts 1--199)
        II  Office of the Secretary, Department of Transportation 
                (Aviation Proceedings) (Parts 200--399)
       III  Commercial Space Transportation, Federal Aviation 
                Administration, Department of Transportation 
                (Parts 400--499)
         V  National Aeronautics and Space Administration (Parts 
                1200--1299)

                 Title 15--Commerce and Foreign Trade

            Subtitle A--Office of the Secretary of Commerce (Parts 
                0--29)
            Subtitle B--Regulations Relating to Commerce and 
                Foreign Trade
         I  Bureau of the Census, Department of Commerce (Parts 
                30--199)
        II  National Institute of Standards and Technology, 
                Department of Commerce (Parts 200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)
        IV  Foreign-Trade Zones Board, Department of Commerce 
                (Parts 400--499)
       VII  Bureau of Export Administration, Department of 
                Commerce (Parts 700--799)
      VIII  Bureau of Economic Analysis, Department of Commerce 
                (Parts 800--899)
        IX  National Oceanic and Atmospheric Administration, 
                Department of Commerce (Parts 900--999)
        XI  Technology Administration, Department of Commerce 
                (Parts 1100--1199)
      XIII  East-West Foreign Trade Board (Parts 1300--1399)

[[Page 684]]

       XIV  Minority Business Development Agency (Parts 1400--
                1499)
            Subtitle C--Regulations Relating to Foreign Trade 
                Agreements
        XX  Office of the United States Trade Representative 
                (Parts 2000--2099)
            Subtitle D--Regulations Relating to Telecommunications 
                and Information
     XXIII  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                2300--2399)

                    Title 16--Commercial Practices

         I  Federal Trade Commission (Parts 0--999)
        II  Consumer Product Safety Commission (Parts 1000--1799)

             Title 17--Commodity and Securities Exchanges

         I  Commodity Futures Trading Commission (Parts 1--199)
        II  Securities and Exchange Commission (Parts 200--399)
        IV  Department of the Treasury (Parts 400--499)

          Title 18--Conservation of Power and Water Resources

         I  Federal Energy Regulatory Commission, Department of 
                Energy (Parts 1--399)
       III  Delaware River Basin Commission (Parts 400--499)
        VI  Water Resources Council (Parts 700--799)
      VIII  Susquehanna River Basin Commission (Parts 800--899)
      XIII  Tennessee Valley Authority (Parts 1300--1399)

                       Title 19--Customs Duties

         I  United States Customs Service, Department of the 
                Treasury (Parts 1--199)
        II  United States International Trade Commission (Parts 
                200--299)
       III  International Trade Administration, Department of 
                Commerce (Parts 300--399)

                     Title 20--Employees' Benefits

         I  Office of Workers' Compensation Programs, Department 
                of Labor (Parts 1--199)
        II  Railroad Retirement Board (Parts 200--399)
       III  Social Security Administration (Parts 400--499)
        IV  Employees' Compensation Appeals Board, Department of 
                Labor (Parts 500--599)
         V  Employment and Training Administration, Department of 
                Labor (Parts 600--699)
        VI  Employment Standards Administration, Department of 
                Labor (Parts 700--799)
       VII  Benefits Review Board, Department of Labor (Parts 
                800--899)

[[Page 685]]

      VIII  Joint Board for the Enrollment of Actuaries (Parts 
                900--999)
        IX  Office of the Assistant Secretary for Veterans' 
                Employment and Training, Department of Labor 
                (Parts 1000--1099)

                       Title 21--Food and Drugs

         I  Food and Drug Administration, Department of Health and 
                Human Services (Parts 1--1299)
        II  Drug Enforcement Administration, Department of Justice 
                (Parts 1300--1399)
       III  Office of National Drug Control Policy (Parts 1400--
                1499)

                      Title 22--Foreign Relations

         I  Department of State (Parts 1--199)
        II  Agency for International Development, International 
                Development Cooperation Agency (Parts 200--299)
       III  Peace Corps (Parts 300--399)
        IV  International Joint Commission, United States and 
                Canada (Parts 400--499)
         V  United States Information Agency (Parts 500--599)
        VI  United States Arms Control and Disarmament Agency 
                (Parts 600--699)
       VII  Overseas Private Investment Corporation, International 
                Development Cooperation Agency (Parts 700--799)
        IX  Foreign Service Grievance Board Regulations (Parts 
                900--999)
         X  Inter-American Foundation (Parts 1000--1099)
        XI  International Boundary and Water Commission, United 
                States and Mexico, United States Section (Parts 
                1100--1199)
       XII  United States International Development Cooperation 
                Agency (Parts 1200--1299)
      XIII  Board for International Broadcasting (Parts 1300--
                1399)
       XIV  Foreign Service Labor Relations Board; Federal Labor 
                Relations Authority; General Counsel of the 
                Federal Labor Relations Authority; and the Foreign 
                Service Impasse Disputes Panel (Parts 1400--1499)
        XV  African Development Foundation (Parts 1500--1599)
       XVI  Japan-United States Friendship Commission (Parts 
                1600--1699)
      XVII  United States Institute of Peace (Parts 1700--1799)

                          Title 23--Highways

         I  Federal Highway Administration, Department of 
                Transportation (Parts 1--999)
        II  National Highway Traffic Safety Administration and 
                Federal Highway Administration, Department of 
                Transportation (Parts 1200--1299)
       III  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 1300--1399)

[[Page 686]]

                Title 24--Housing and Urban Development

            Subtitle A--Office of the Secretary, Department of 
                Housing and Urban Development (Parts 0--99)
            Subtitle B--Regulations Relating to Housing and Urban 
                Development
         I  Office of Assistant Secretary for Equal Opportunity, 
                Department of Housing and Urban Development (Parts 
                100--199)
        II  Office of Assistant Secretary for Housing-Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 200--299)
       III  Government National Mortgage Association, Department 
                of Housing and Urban Development (Parts 300--399)
         V  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 500--599)
        VI  Office of Assistant Secretary for Community Planning 
                and Development, Department of Housing and Urban 
                Development (Parts 600--699) [Reserved]
       VII  Office of the Secretary, Department of Housing and 
                Urban Development (Housing Assistance Programs and 
                Public and Indian Housing Programs) (Parts 700--
                799)
      VIII  Office of the Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Section 8 Housing Assistance 
                Programs and Section 202 Direct Loan Program) 
                (Parts 800--899)
        IX  Office of Assistant Secretary for Public and Indian 
                Housing, Department of Housing and Urban 
                Development (Parts 900--999)
         X  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Interstate Land Sales 
                Registration Program) (Parts 1700--1799)
       XII  Office of Inspector General, Department of Housing and 
                Urban Development (Parts 2000--2099)
        XX  Office of Assistant Secretary for Housing--Federal 
                Housing Commissioner, Department of Housing and 
                Urban Development (Parts 3200--3899)
       XXV  Neighborhood Reinvestment Corporation (Parts 4100--
                4199)

                           Title 25--Indians

         I  Bureau of Indian Affairs, Department of the Interior 
                (Parts 1--299)
        II  Indian Arts and Crafts Board, Department of the 
                Interior (Parts 300--399)
       III  National Indian Gaming Commission, Department of the 
                Interior (Parts 500--599)
        IV  Office of Navajo and Hopi Indian Relocation (Parts 
                700--799)
         V  Bureau of Indian Affairs, Department of the Interior, 
                and Indian Health Service, Department of Health 
                and Human Services (Part 900)
        VI  Office of the Assistant Secretary-Indian Affairs, 
                Department of the Interior (Part 1001)

[[Page 687]]

       VII  Office of the Special Trustee for American Indians, 
                Department of the Interior (Parts 1200--1299)

                      Title 26--Internal Revenue

         I  Internal Revenue Service, Department of the Treasury 
                (Parts 1--799)

           Title 27--Alcohol, Tobacco Products and Firearms

         I  Bureau of Alcohol, Tobacco and Firearms, Department of 
                the Treasury (Parts 1--299)

                   Title 28--Judicial Administration

         I  Department of Justice (Parts 0--199)
       III  Federal Prison Industries, Inc., Department of Justice 
                (Parts 300--399)
         V  Bureau of Prisons, Department of Justice (Parts 500--
                599)
        VI  Offices of Independent Counsel, Department of Justice 
                (Parts 600--699)
       VII  Office of Independent Counsel (Parts 700--799)

                            Title 29--Labor

            Subtitle A--Office of the Secretary of Labor (Parts 
                0--99)
            Subtitle B--Regulations Relating to Labor
         I  National Labor Relations Board (Parts 100--199)
        II  Office of Labor-Management Standards, Department of 
                Labor (Parts 200--299)
       III  National Railroad Adjustment Board (Parts 300--399)
        IV  Office of Labor-Management Standards, Department of 
                Labor (Parts 400--499)
         V  Wage and Hour Division, Department of Labor (Parts 
                500--899)
        IX  Construction Industry Collective Bargaining Commission 
                (Parts 900--999)
         X  National Mediation Board (Parts 1200--1299)
       XII  Federal Mediation and Conciliation Service (Parts 
                1400--1499)
       XIV  Equal Employment Opportunity Commission (Parts 1600--
                1699)
      XVII  Occupational Safety and Health Administration, 
                Department of Labor (Parts 1900--1999)
        XX  Occupational Safety and Health Review Commission 
                (Parts 2200--2499)
       XXV  Pension and Welfare Benefits Administration, 
                Department of Labor (Parts 2500--2599)
     XXVII  Federal Mine Safety and Health Review Commission 
                (Parts 2700--2799)
        XL  Pension Benefit Guaranty Corporation (Parts 4000--
                4999)

[[Page 688]]

                      Title 30--Mineral Resources

         I  Mine Safety and Health Administration, Department of 
                Labor (Parts 1--199)
        II  Minerals Management Service, Department of the 
                Interior (Parts 200--299)
       III  Board of Surface Mining and Reclamation Appeals, 
                Department of the Interior (Parts 300--399)
        IV  Geological Survey, Department of the Interior (Parts 
                400--499)
        VI  Bureau of Mines, Department of the Interior (Parts 
                600--699)
       VII  Office of Surface Mining Reclamation and Enforcement, 
                Department of the Interior (Parts 700--999)

                 Title 31--Money and Finance: Treasury

            Subtitle A--Office of the Secretary of the Treasury 
                (Parts 0--50)
            Subtitle B--Regulations Relating to Money and Finance
         I  Monetary Offices, Department of the Treasury (Parts 
                51--199)
        II  Fiscal Service, Department of the Treasury (Parts 
                200--399)
        IV  Secret Service, Department of the Treasury (Parts 
                400--499)
         V  Office of Foreign Assets Control, Department of the 
                Treasury (Parts 500--599)
        VI  Bureau of Engraving and Printing, Department of the 
                Treasury (Parts 600--699)
       VII  Federal Law Enforcement Training Center, Department of 
                the Treasury (Parts 700--799)
      VIII  Office of International Investment, Department of the 
                Treasury (Parts 800--899)

                      Title 32--National Defense

            Subtitle A--Department of Defense
         I  Office of the Secretary of Defense (Parts 1--399)
         V  Department of the Army (Parts 400--699)
        VI  Department of the Navy (Parts 700--799)
       VII  Department of the Air Force (Parts 800--1099)
            Subtitle B--Other Regulations Relating to National 
                Defense
       XII  Defense Logistics Agency (Parts 1200--1299)
       XVI  Selective Service System (Parts 1600--1699)
       XIX  Central Intelligence Agency (Parts 1900--1999)
        XX  Information Security Oversight Office, National 
                Archives and Records Administration (Parts 2000--
                2099)
       XXI  National Security Council (Parts 2100--2199)
      XXIV  Office of Science and Technology Policy (Parts 2400--
                2499)
     XXVII  Office for Micronesian Status Negotiations (Parts 
                2700--2799)
    XXVIII  Office of the Vice President of the United States 
                (Parts 2800--2899)
      XXIX  Presidential Commission on the Assignment of Women in 
                the Armed Forces (Part 2900)

[[Page 689]]

               Title 33--Navigation and Navigable Waters

         I  Coast Guard, Department of Transportation (Parts 1--
                199)
        II  Corps of Engineers, Department of the Army (Parts 
                200--399)
        IV  Saint Lawrence Seaway Development Corporation, 
                Department of Transportation (Parts 400--499)

                          Title 34--Education

            Subtitle A--Office of the Secretary, Department of 
                Education (Parts 1--99)
            Subtitle B--Regulations of the Offices of the 
                Department of Education
         I  Office for Civil Rights, Department of Education 
                (Parts 100--199)
        II  Office of Elementary and Secondary Education, 
                Department of Education (Parts 200--299)
       III  Office of Special Education and Rehabilitative 
                Services, Department of Education (Parts 300--399)
        IV  Office of Vocational and Adult Education, Department 
                of Education (Parts 400--499)
         V  Office of Bilingual Education and Minority Languages 
                Affairs, Department of Education (Parts 500--599)
        VI  Office of Postsecondary Education, Department of 
                Education (Parts 600--699)
       VII  Office of Educational Research and Improvement, 
                Department of Education (Parts 700--799)
        XI  National Institute for Literacy (Parts 1100-1199)
            Subtitle C--Regulations Relating to Education
       XII  National Council on Disability (Parts 1200--1299)

                        Title 35--Panama Canal

         I  Panama Canal Regulations (Parts 1--299)

             Title 36--Parks, Forests, and Public Property

         I  National Park Service, Department of the Interior 
                (Parts 1--199)
        II  Forest Service, Department of Agriculture (Parts 200--
                299)
       III  Corps of Engineers, Department of the Army (Parts 
                300--399)
        IV  American Battle Monuments Commission (Parts 400--499)
         V  Smithsonian Institution (Parts 500--599)
       VII  Library of Congress (Parts 700--799)
      VIII  Advisory Council on Historic Preservation (Parts 800--
                899)
        IX  Pennsylvania Avenue Development Corporation (Parts 
                900--999)
        XI  Architectural and Transportation Barriers Compliance 
                Board (Parts 1100--1199)
       XII  National Archives and Records Administration (Parts 
                1200--1299)
       XIV  Assassination Records Review Board (Parts 1400-1499)

[[Page 690]]

             Title 37--Patents, Trademarks, and Copyrights

         I  Patent and Trademark Office, Department of Commerce 
                (Parts 1--199)
        II  Copyright Office, Library of Congress (Parts 200--299)
        IV  Assistant Secretary for Technology Policy, Department 
                of Commerce (Parts 400--499)
         V  Under Secretary for Technology, Department of Commerce 
                (Parts 500--599)

           Title 38--Pensions, Bonuses, and Veterans' Relief

         I  Department of Veterans Affairs (Parts 0--99)

                       Title 39--Postal Service

         I  United States Postal Service (Parts 1--999)
       III  Postal Rate Commission (Parts 3000--3099)

                  Title 40--Protection of Environment

         I  Environmental Protection Agency (Parts 1--799)
         V  Council on Environmental Quality (Parts 1500--1599)

          Title 41--Public Contracts and Property Management

            Subtitle B--Other Provisions Relating to Public 
                Contracts
        50  Public Contracts, Department of Labor (Parts 50-1--50-
                999)
        51  Committee for Purchase From People Who Are Blind or 
                Severely Disabled (Parts 51-1--51-99)
        60  Office of Federal Contract Compliance Programs, Equal 
                Employment Opportunity, Department of Labor (Parts 
                60-1--60-999)
        61  Office of the Assistant Secretary for Veterans 
                Employment and Training, Department of Labor 
                (Parts 61-1--61-999)
            Subtitle C--Federal Property Management Regulations 
                System
       101  Federal Property Management Regulations (Parts 101-1--
                101-99)
       105  General Services Administration (Parts 105-1--105-999)
       109  Department of Energy Property Management Regulations 
                (Parts 109-1--109-99)
       114  Department of the Interior (Parts 114-1--114-99)
       115  Environmental Protection Agency (Parts 115-1--115-99)
       128  Department of Justice (Parts 128-1--128-99)
            Subtitle D--Other Provisions Relating to Property 
                Management [Reserved]
            Subtitle E--Federal Information Resources Management 
                Regulations System
       201  Federal Information Resources Management Regulation 
                (Parts 201-1--201-99) [Reserved]
            Subtitle F--Federal Travel Regulation System
       301  Travel Allowances (Parts 301-1--301-99)
       302  Relocation Allowances (Parts 302-1--302-99)

[[Page 691]]

       303  Payment of Expenses Connected with the Death of 
                Certain Employees (Parts 303-1--303-2)
       304  Payment from a Non-Federal Source for Travel Expenses 
                (Parts 304-1--304-99)

                        Title 42--Public Health

         I  Public Health Service, Department of Health and Human 
                Services (Parts 1--199)
        IV  Health Care Financing Administration, Department of 
                Health and Human Services (Parts 400--499)
         V  Office of Inspector General-Health Care, Department of 
                Health and Human Services (Parts 1000--1999)

                   Title 43--Public Lands: Interior

            Subtitle A--Office of the Secretary of the Interior 
                (Parts 1--199)
            Subtitle B--Regulations Relating to Public Lands
         I  Bureau of Reclamation, Department of the Interior 
                (Parts 200--499)
        II  Bureau of Land Management, Department of the Interior 
                (Parts 1000--9999)
       III  Utah Reclamation Mitigation and Conservation 
                Commission (Parts 10000--10005)

             Title 44--Emergency Management and Assistance

         I  Federal Emergency Management Agency (Parts 0--399)
        IV  Department of Commerce and Department of 
                Transportation (Parts 400--499)

                       Title 45--Public Welfare

            Subtitle A--Department of Health and Human Services, 
                General Administration (Parts 1--199)
            Subtitle B--Regulations Relating to Public Welfare
        II  Office of Family Assistance (Assistance Programs), 
                Administration for Children and Families, 
                Department of Health and Human Services (Parts 
                200--299)
       III  Office of Child Support Enforcement (Child Support 
                Enforcement Program), Administration for Children 
                and Families, Department of Health and Human 
                Services (Parts 300--399)
        IV  Office of Refugee Resettlement, Administration for 
                Children and Families Department of Health and 
                Human Services (Parts 400--499)
         V  Foreign Claims Settlement Commission of the United 
                States, Department of Justice (Parts 500--599)
        VI  National Science Foundation (Parts 600--699)
       VII  Commission on Civil Rights (Parts 700--799)
      VIII  Office of Personnel Management (Parts 800--899)

[[Page 692]]

         X  Office of Community Services, Administration for 
                Children and Families, Department of Health and 
                Human Services (Parts 1000--1099)
        XI  National Foundation on the Arts and the Humanities 
                (Parts 1100--1199)
       XII  ACTION (Parts 1200--1299)
      XIII  Office of Human Development Services, Department of 
                Health and Human Services (Parts 1300--1399)
       XVI  Legal Services Corporation (Parts 1600--1699)
      XVII  National Commission on Libraries and Information 
                Science (Parts 1700--1799)
     XVIII  Harry S. Truman Scholarship Foundation (Parts 1800--
                1899)
       XXI  Commission on Fine Arts (Parts 2100--2199)
      XXII  Christopher Columbus Quincentenary Jubilee Commission 
                (Parts 2200--2299)
     XXIII  Arctic Research Commission (Part 2301)
      XXIV  James Madison Memorial Fellowship Foundation (Parts 
                2400--2499)
       XXV  Corporation for National and Community Service (Parts 
                2500--2599)

                          Title 46--Shipping

         I  Coast Guard, Department of Transportation (Parts 1--
                199)
        II  Maritime Administration, Department of Transportation 
                (Parts 200--399)
        IV  Federal Maritime Commission (Parts 500--599)

                      Title 47--Telecommunication

         I  Federal Communications Commission (Parts 0--199)
        II  Office of Science and Technology Policy and National 
                Security Council (Parts 200--299)
       III  National Telecommunications and Information 
                Administration, Department of Commerce (Parts 
                300--399)

           Title 48--Federal Acquisition Regulations System

         1  Federal Acquisition Regulation (Parts 1--99)
         2  Department of Defense (Parts 200--299)
         3  Department of Health and Human Services (Parts 300--
                399)
         4  Department of Agriculture (Parts 400--499)
         5  General Services Administration (Parts 500--599)
         6  Department of State (Parts 600--699)
         7  Agency for International Development (Parts 700--799)
         8  Department of Veterans Affairs (Parts 800--899)
         9  Department of Energy (Parts 900--999)
        10  Department of the Treasury (Parts 1000--1099)

[[Page 693]]

        12  Department of Transportation (Parts 1200--1299)
        13  Department of Commerce (Parts 1300--1399)
        14  Department of the Interior (Parts 1400--1499)
        15  Environmental Protection Agency (Parts 1500--1599)
        16  Office of Personnel Management Federal Employees 
                Health Benefits Acquisition Regulation (Parts 
                1600--1699)
        17  Office of Personnel Management (Parts 1700--1799)
        18  National Aeronautics and Space Administration (Parts 
                1800--1899)
        19  United States Information Agency (Parts 1900--1999)
        20  Nuclear Regulatory Commission (Parts 2000--2099)
        21  Office of Personnel Management, Federal Employees 
                Group Life Insurance Federal Acquisition 
                Regulation (Parts 2100--2199)
        23  Social Security Administration (Parts 2300--2399)
        24  Department of Housing and Urban Development (Parts 
                2400--2499)
        25  National Science Foundation (Parts 2500--2599)
        28  Department of Justice (Parts 2800--2899)
        29  Department of Labor (Parts 2900--2999)
        34  Department of Education Acquisition Regulation (Parts 
                3400--3499)
        35  Panama Canal Commission (Parts 3500--3599)
        44  Federal Emergency Management Agency (Parts 4400--4499)
        51  Department of the Army Acquisition Regulations (Parts 
                5100--5199)
        52  Department of the Navy Acquisition Regulations (Parts 
                5200--5299)
        53  Department of the Air Force Federal Acquisition 
                Regulation Supplement (Parts 5300--5399)
        54  Defense Logistics Agency, Department of Defense (Part 
                5452)
        57  African Development Foundation (Parts 5700--5799)
        61  General Services Administration Board of Contract 
                Appeals (Parts 6100--6199)
        63  Department of Transportation Board of Contract Appeals 
                (Parts 6300--6399)
        99  Cost Accounting Standards Board, Office of Federal 
                Procurement Policy, Office of Management and 
                Budget (Parts 9900--9999)

                       Title 49--Transportation

            Subtitle A--Office of the Secretary of Transportation 
                (Parts 1--99)
            Subtitle B--Other Regulations Relating to 
                Transportation
         I  Research and Special Programs Administration, 
                Department of Transportation (Parts 100--199)
        II  Federal Railroad Administration, Department of 
                Transportation (Parts 200--299)

[[Page 694]]

       III  Federal Highway Administration, Department of 
                Transportation (Parts 300--399)
        IV  Coast Guard, Department of Transportation (Parts 400--
                499)
         V  National Highway Traffic Safety Administration, 
                Department of Transportation (Parts 500--599)
        VI  Federal Transit Administration, Department of 
                Transportation (Parts 600--699)
       VII  National Railroad Passenger Corporation (AMTRAK) 
                (Parts 700--799)
      VIII  National Transportation Safety Board (Parts 800--999)
         X  Surface Transportation Board, Department of 
                Transportation (Parts 1000--1399)

                   Title 50--Wildlife and Fisheries

         I  United States Fish and Wildlife Service, Department of 
                the Interior (Parts 1--199)
        II  National Marine Fisheries Service, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 200--299)
       III  International Fishing and Related Activities (Parts 
                300--399)
        IV  Joint Regulations (United States Fish and Wildlife 
                Service, Department of the Interior and National 
                Marine Fisheries Service, National Oceanic and 
                Atmospheric Administration, Department of 
                Commerce); Endangered Species Committee 
                Regulations (Parts 400--499)
         V  Marine Mammal Commission (Parts 500--599)
        VI  Fishery Conservation and Management, National Oceanic 
                and Atmospheric Administration, Department of 
                Commerce (Parts 600--699)

                      CFR Index and Finding Aids

            Subject/Agency Index
            List of Agency Prepared Indexes
            Parallel Tables of Statutory Authorities and Rules
            Acts Requiring Publication in the Federal Register
            List of CFR Titles, Chapters, Subchapters, and Parts
            Alphabetical List of Agencies Appearing in the CFR



[[Page 695]]





           Alphabetical List of Agencies Appearing in the CFR




                      (Revised as of April 1, 1997)

                                                  CFR Title, Subtitle or
                     Agency                               Chapter

ACTION                                            45, XII
Administrative Committee of the Federal Register  1, I
Advanced Research Projects Agency                 32, I
Advisory Commission on Intergovernmental          5, VII
     Relations
Advisory Committee on Federal Pay                 5, IV
Advisory Council on Historic Preservation         36, VIII
African Development Foundation                    22, XV
  Federal Acquisition Regulation                  48, 57
Agency for International Development              22, II
  Federal Acquisition Regulation                  48, 7
Agricultural Marketing Service                    7, I, IX, X, XI
Agricultural Research Service                     7, V
Agriculture Department
  Agricultural Marketing Service                  7, I, IX, X, XI
  Agricultural Research Service                   7, V
  Animal and Plant Health Inspection Service      7, III; 9, I
  Commodity Credit Corporation                    7, XIV
  Cooperative State Research, Education, and      7, XXXIV
       Extension Service
  Economic Research Service                       7, XXXVII
  Energy, Office of                               7, XXIX
  Environmental Quality, Office of                7, XXXI
  Farm Service Agency                             7, VII, XVIII
  Federal Acquisition Regulation                  48, 4
  Federal Crop Insurance Corporation              7, IV
  Finance and Management, Office of               7, XXX
  Food and Consumer Service                       7, II
  Food Safety and Inspection Service              9, III
  Foreign Agricultural Service                    7, XV
  Forest Service                                  36, II
  Grain Inspection, Packers and Stockyards        7, VIII; 9, II
       Administration
  Information Resources Management, Office of     7, XXVII
  Inspector General, Office of                    7, XXVI
  National Agricultural Library                   7, XLI
  National Agricultural Statistics Service        7, XXXVI
  Natural Resources Conservation Service          7, VI
  Operations, Office of                           7, XXVIII
  Rural Business-Cooperative Service              7, XVIII, XLII
  Rural Development Administration                7, XLII
  Rural Housing Service                           7, XVIII, XXXV
  Rural Telephone Bank                            7, XVI
  Rural Utilities Service                         7, XVII, XVIII, XLII
  Secretary of Agriculture, Office of             7, Subtitle A
  Transportation, Office of                       7, XXXIII
  World Agricultural Outlook Board                7, XXXVIII
Air Force Department                              32, VII
  Federal Acquisition Regulation Supplement       48, 53
Alaska Natural Gas Transportation System, Office  10, XV
     of the Federal Inspector
Alcohol, Tobacco and Firearms, Bureau of          27, I
AMTRAK                                            49, VII
American Battle Monuments Commission              36, IV
Animal and Plant Health Inspection Service        7, III; 9, I

[[Page 696]]

Appalachian Regional Commission                   5, IX
Architectural and Transportation Barriers         36, XI
     Compliance Board
Arctic Research Commission                        45, XXIII
Armed Forces Retirement Home                      5, XI
Arms Control and Disarmament Agency, United       22, VI
     States
Army Department                                   32, V
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 51
Assassination Records Review Board                36, XIV
Benefits Review Board                             20, VII
Bilingual Education and Minority Languages        34, V
     Affairs, Office of
Blind or Severely Disabled, Committee for         41, 51
     Purchase From People Who Are
Board for International Broadcasting              22, XIII
Census Bureau                                     15, I
Central Intelligence Agency                       32, XIX
Child Support Enforcement, Office of              45, III
Children and Families, Administration for         45, II, III, IV, X
Christopher Columbus Quincentenary Jubilee        45, XXII
     Commission
Civil Rights, Commission on                       45, VII
Civil Rights, Office for                          34, I
Coast Guard                                       33, I; 46, I; 49, IV
Commerce Department                               44, IV
  Census Bureau                                   15, I`
  Economic Affairs, Under Secretary               37, V
  Economic Analysis, Bureau of                    15, VIII
  Economic Development Administration             13, III
  Emergency Management and Assistance             44, IV
  Export Administration, Bureau of                15, VII
  Federal Acquisition Regulation                  48, 13
  Fishery Conservation and Management             50, VI
  Foreign-Trade Zones Board                       15, IV
  International Trade Administration              15, III; 19, III
  National Institute of Standards and Technology  15, II
  National Marine Fisheries Service               50, II, IV
  National Oceanic and Atmospheric                15, IX; 50, II, III, IV, 
       Administration                             VI
  National Telecommunications and Information     15, XXIII; 47, III
       Administration
  National Weather Service                        15, IX
  Patent and Trademark Office                     37, I
  Productivity, Technology and Innovation,        37, IV
       Assistant Secretary for
  Secretary of Commerce, Office of                15, Subtitle A
  Technology, Under Secretary for                 37, V
  Technology Administration                       15, XI
  Technology Policy, Assistant Secretary for      37, IV
Commercial Space Transportation                   14, III
Commodity Credit Corporation                      7, XIV
Commodity Futures Trading Commission              5, XLI; 17, I
Community Planning and Development, Office of     24, V, VI
     Assistant Secretary for
Community Services, Office of                     45, X
Comptroller of the Currency                       12, I
Construction Industry Collective Bargaining       29, IX
     Commission
Consumer Product Safety Commission                5, LXXI; 16, II
Cooperative State Research, Education, and        7, XXXIV
     Extension Service
Copyright Office                                  37, II
Cost Accounting Standards Board                   48, 99
Council on Environmental Quality                  40, V
Customs Service, United States                    19, I
Defense Contract Audit Agency                     32, I
Defense Department                                5, XXVI; 32, Subtitle A
  Advanced Research Projects Agency               32, I
  Air Force Department                            32, VII
  Army Department                                 32, V; 33, II; 36, III, 
                                                  48, 51
  Defense Intelligence Agency                     32, I

[[Page 697]]

  Defense Logistics Agency                        32, I, XII; 48, 54
  Defense Mapping Agency                          32, I
  Engineers, Corps of                             33, II; 36, III
  Federal Acquisition Regulation                  48, 2
  Navy Department                                 32, VI; 48, 52
  Secretary of Defense, Office of                 32, I
Defense Contract Audit Agency                     32, I
Defense Intelligence Agency                       32, I
Defense Logistics Agency                          32, XII; 48, 54
Defense Mapping Agency                            32, I
Defense Nuclear Facilities Safety Board           10, XVII
Delaware River Basin Commission                   18, III
Drug Enforcement Administration                   21, II
East-West Foreign Trade Board                     15, XIII
Economic Affairs, Under Secretary                 37, V
Economic Analysis, Bureau of                      15, VIII
Economic Development Administration               13, III
Economic Research Service                         7, XXXVII
Education, Department of                          5, LIII
  Bilingual Education and Minority Languages      34, V
       Affairs, Office of
  Civil Rights, Office for                        34, I
  Educational Research and Improvement, Office    34, VII
       of
  Elementary and Secondary Education, Office of   34, II
  Federal Acquisition Regulation                  48, 34
  Postsecondary Education, Office of              34, VI
  Secretary of Education, Office of               34, Subtitle A
  Special Education and Rehabilitative Services,  34, III
       Office of
  Vocational and Adult Education, Office of       34, IV
Educational Research and Improvement, Office of   34, VII
Elementary and Secondary Education, Office of     34, II
Employees' Compensation Appeals Board             20, IV
Employees Loyalty Board                           5, V
Employment and Training Administration            20, V
Employment Standards Administration               20, VI
Endangered Species Committee                      50, IV
Energy, Department of                             5, XXIII; 10, II, III, X
  Federal Acquisition Regulation                  48, 9
  Federal Energy Regulatory Commission            5, XXIV; 18, I
  Property Management Regulations                 41, 109
Energy, Office of                                 7, XXIX
Engineers, Corps of                               33, II; 36, III
Engraving and Printing, Bureau of                 31, VI
Enrichment Corporation, United States             10, XI
Environmental Protection Agency                   5, LIV; 40, I
  Federal Acquisition Regulation                  48, 15
  Property Management Regulations                 41, 115
Environmental Quality, Office of                  7, XXXI
Equal Employment Opportunity Commission           5, LXII; 29, XIV
Equal Opportunity, Office of Assistant Secretary  24, I
     for
Executive Office of the President                 3, I
  Administration, Office of                       5, XV
  Environmental Quality, Council on               40, V
  Management and Budget, Office of                25, III, LXXVII; 48, 99
  National Drug Control Policy, Office of         21, III
  National Security Council                       32, XXI; 47, 2
  Presidential Documents                          3
  Science and Technology Policy, Office of        32, XXIV; 47, II
  Trade Representative, Office of the United      15, XX
       States
Export Administration, Bureau of                  15, VII
Export-Import Bank of the United States           5, LII; 12, IV
Family Assistance, Office of                      45, II
Farm Credit Administration                        5, XXXI; 12, VI
Farm Credit System Insurance Corporation          5, XXX; 12, XIV
Farm Service Agency                               7, VII, XVIII
Federal Acquisition Regulation                    48, 1
Federal Aviation Administration                   14, I
  Commercial Space Transportation                 14, III

[[Page 698]]

Federal Claims Collection Standards               4, II
Federal Communications Commission                 5, XXIX; 47, I
Federal Contract Compliance Programs, Office of   41, 60
Federal Crop Insurance Corporation                7, IV
Federal Deposit Insurance Corporation             5, XXII; 12, III
Federal Election Commission                       11, I
Federal Emergency Management Agency               44, I
  Federal Acquisition Regulation                  48, 44
Federal Employees Group Life Insurance Federal    48, 21
     Acquisition Regulation
Federal Employees Health Benefits Acquisition     48, 16
     Regulation
Federal Energy Regulatory Commission              5, XXIV; 18, I
Federal Financial Institutions Examination        12, XI
     Council
Federal Financing Bank                            12, VIII
Federal Highway Administration                    23, I, II; 49, III
Federal Home Loan Mortgage Corporation            1, IV
Federal Housing Enterprise Oversight Office       12, XVII
Federal Housing Finance Board                     12, IX
Federal Inspector for the Alaska Natural Gas      10, XV
     Transportation System, Office of
Federal Labor Relations Authority, and General    5, XIV; 22, XIV
     Counsel of the Federal Labor Relations 
     Authority
Federal Law Enforcement Training Center           31, VII
Federal Maritime Commission                       46, IV
Federal Mediation and Conciliation Service        29, XII
Federal Mine Safety and Health Review Commission  5, LXXIV; 29, XXVII
Federal Pay, Advisory Committee on                5, IV
Federal Prison Industries, Inc.                   28, III
Federal Procurement Policy Office                 48, 99
Federal Property Management Regulations           41, 101
Federal Property Management Regulations System    41, Subtitle C
Federal Railroad Administration                   49, II
Federal Register, Administrative Committee of     1, I
Federal Register, Office of                       1, II
Federal Reserve System                            12, II
  Board of Governors                              5, LVIII
Federal Retirement Thrift Investment Board        5, VI, LXXVI
Federal Service Impasses Panel                    5, XIV
Federal Trade Commission                          5, XLVII; 16, I
Federal Transit Administration                    49, VI
Federal Travel Regulation System                  41, Subtitle F
Finance and Management, Office of                 7, XXX
Fine Arts, Commission on                          45, XXI
Fiscal Service                                    31, II
Fish and Wildlife Service, United States          50, I, IV
Fishery Conservation and Management               50, VI
Food and Drug Administration                      21, I
Food and Consumer Service                         7, II
Food Safety and Inspection Service                9, III
Foreign Agricultural Service                      7, XV
Foreign Assets Control, Office of                 31, V
Foreign Claims Settlement Commission of the       45, V
     United States
Foreign Service Grievance Board                   22, IX
Foreign Service Impasse Disputes Panel            22, XIV
Foreign Service Labor Relations Board             22, XIV
Foreign-Trade Zones Board                         15, IV
Forest Service                                    36, II
General Accounting Office                         4, I, II
General Services Administration                   5, LVII
  Contract Appeals, Board of                      48, 61
  Federal Acquisition Regulation                  48, 5
  Federal Property Management Regulations System  41, 101, 105
  Federal Travel Regulation System                41, Subtitle F
  Payment From a Non-Federal Source for Travel    41, 304
       Expenses
  Payment of Expenses Connected With the Death    41, 303
       of Certain Employees
  Relocation Allowances                           41, 302
  Travel Allowances                               41, 301

[[Page 699]]

Geological Survey                                 30, IV
Government Ethics, Office of                      5, XVI
Government National Mortgage Association          24, III
Grain Inspection, Packers and Stockyards          7, VIII; 9, II
     Administration
Great Lakes Pilotage                              46, III
Harry S. Truman Scholarship Foundation            45, XVIII
Health and Human Services, Department of          5, XLV; 45, Subtitle A
  Child Support Enforcement, Office of            45, III
  Children and Families, Administration for       45, II, III, IV, X
  Community Services, Office of                   45, X
  Family Assistance, Office of                    45, II
  Federal Acquisition Regulation                  48, 3
  Food and Drug Administration                    21, I
  Health Care Financing Administration            42, IV
  Human Development Services, Office of           45, XIII
  Indian Health Service                           25, V
  Inspector General (Health Care), Office of      42, V
  Public Health Service                           42, I
  Refugee Resettlement, Office of                 45, IV
Health Care Financing Administration              42, IV
Housing and Urban Development, Department of      5, LXV; 24, Subtitle B
  Community Planning and Development, Office of   24, V, VI
       Assistant Secretary for
  Equal Opportunity, Office of Assistant          24, I
       Secretary for
  Federal Acquisition Regulation                  48, 24
  Federal Housing Enterprise Oversight, Office    12, XVII
       of
  Government National Mortgage Association        24, III
  Housing--Federal Housing Commissioner, Office   24, II, VIII, X, XX
       of Assistant Secretary for
  Inspector General, Office of                    24, XII
  Public and Indian Housing, Office of Assistant  24, IX
       Secretary for
  Secretary, Office of                            24, Subtitle A, VII
Housing--Federal Housing Commissioner, Office of  24, II, VIII, X, XX
     Assistant Secretary for
Human Development Services, Office of             45, XIII
Immigration and Naturalization Service            8, I
Independent Counsel, Office of                    28, VII
Indian Affairs, Bureau of                         25, I, V
Indian Affairs, Office of the Assistant           25, VI
     Secretary
Indian Arts and Crafts Board                      25, II
Indian Health Service                             25, V
Information Agency, United States                 22, V
  Federal Acquisition Regulation                  48, 19
Information Resources Management, Office of       7, XXVII
Information Security Oversight Office, National   32, XX
     Archives and Records Administration
Inspector General
  Agriculture Department                          7, XXVI
  Health and Human Services Department            42, V
  Housing and Urban Development Department        24, XII
Institute of Peace, United States                 22, XVII
Inter-American Foundation                         5, LXIII; 22, X
Intergovernmental Relations, Advisory Commission  5, VII
     on
Interior Department
  Endangered Species Committee                    50, IV
  Federal Acquisition Regulation                  48, 14
  Federal Property Management Regulations System  41, 114
  Fish and Wildlife Service, United States        50, I, IV
  Geological Survey                               30, IV
  Indian Affairs, Bureau of                       25, I, V
  Indian Affairs, Office of the Assistant         25, VI
       Secretary
  Indian Arts and Crafts Board                    25, II
  Land Management, Bureau of                      43, II
  Minerals Management Service                     30, II
  Mines, Bureau of                                30, VI
  National Indian Gaming Commission               25, III
  National Park Service                           36, I
  Reclamation, Bureau of                          43, I

[[Page 700]]

  Secretary of the Interior, Office of            43, Subtitle A
  Surface Mining and Reclamation Appeals, Board   30, III
       of
  Surface Mining Reclamation and Enforcement,     30, VII
       Office of
Internal Revenue Service                          26, I
International Boundary and Water Commission,      22, XI
     United States and Mexico, United States 
     Section
International Development, Agency for             22, II
  Federal Acquisition Regulation                  48, 7
International Development Cooperation Agency,     22, XII
     United States
  International Development, Agency for           22, II; 48, 7
  Overseas Private Investment Corporation         5, XXXIII; 22, VII
International Fishing and Related Activities      50, III
International Investment, Office of               31, VIII
International Joint Commission, United States     22, IV
     and Canada
International Organizations Employees Loyalty     5, V
     Board
International Trade Administration                15, III; 19, III
International Trade Commission, United States     19, II
Interstate Commerce Commission                    5, XL
James Madison Memorial Fellowship Foundation      45, XXIV
Japan-United States Friendship Commission         22, XVI
Joint Board for the Enrollment of Actuaries       20, VIII
Justice Department                                5, XXVIII; 28, I
  Drug Enforcement Administration                 21, II
  Federal Acquisition Regulation                  48, 28
  Federal Claims Collection Standards             4, II
  Federal Prison Industries, Inc.                 28, III
  Foreign Claims Settlement Commission of the     45, V
       United States
  Immigration and Naturalization Service          8, I
  Offices of Independent Counsel                  28, VI
  Prisons, Bureau of                              28, V
  Property Management Regulations                 41, 128
Labor Department                                  5, XLII
  Benefits Review Board                           20, VII
  Employees' Compensation Appeals Board           20, IV
  Employment and Training Administration          20, V
  Employment Standards Administration             20, VI
  Federal Acquisition Regulation                  48, 29
  Federal Contract Compliance Programs, Office    41, 60
       of
  Federal Procurement Regulations System          41, 50
  Labor-Management Relations and Cooperative      29, II
       Programs, Bureau of
  Labor-Management Programs, Office of            29, IV
  Mine Safety and Health Administration           30, I
  Occupational Safety and Health Administration   29, XVII
  Pension and Welfare Benefits Administration     29, XXV
  Public Contracts                                41, 50
  Secretary of Labor, Office of                   29, Subtitle A
  Veterans' Employment and Training, Office of    41, 61; 20, IX
       the Assistant Secretary for
  Wage and Hour Division                          29, V
  Workers' Compensation Programs, Office of       20, I
Labor-Management Relations and Cooperative        29, II
     Programs, Bureau of
Labor-Management Programs, Office of              29, IV
Land Management, Bureau of                        43, II
Legal Services Corporation                        45, XVI
Library of Congress                               36, VII
  Copyright Office                                37, II
Management and Budget, Office of                  5, III, LXXVII; 48, 99
Marine Mammal Commission                          50, V
Maritime Administration                           46, II
Merit Systems Protection Board                    5, II
Micronesian Status Negotiations, Office for       32, XXVII
Mine Safety and Health Administration             30, I
Minerals Management Service                       30, II
Mines, Bureau of                                  30, VI

[[Page 701]]

Minority Business Development Agency              15, XIV
Miscellaneous Agencies                            1, IV
Monetary Offices                                  31, I
National Aeronautics and Space Administration     5, LIX; 14, V
  Federal Acquisition Regulation                  48, 18
National Agricultural Library                     7, XLI
National Agricultural Statistics Service          7, XXXVI
National Archives and Records Administration      5, LXVI; 36, XII
  Information Security Oversight Office           32, XX
National Bureau of Standards                      15, II
National Capital Planning Commission              1, IV
National Commission for Employment Policy         1, IV
National Commission on Libraries and Information  45, XVII
     Science
National and Community Service, Corporation for   45, XXV
National Council on Disability                    34, XII
National Credit Union Administration              12, VII
National Drug Control Policy, Office of           21, III
National Foundation on the Arts and the           45, XI
     Humanities
National Highway Traffic Safety Administration    23, II, III; 49, V
National Indian Gaming Commission                 25, III
National Institute for Literacy                   34, XI
National Institute of Standards and Technology    15, II
National Labor Relations Board                    29, I
National Marine Fisheries Service                 50, II, IV
National Mediation Board                          29, X
National Oceanic and Atmospheric Administration   15, IX; 50, II, III, IV, 
                                                  VI
National Park Service                             36, I
National Railroad Adjustment Board                29, III
National Railroad Passenger Corporation (AMTRAK)  49, VII
National Science Foundation                       5, XLIII; 45, VI
  Federal Acquisition Regulation                  48, 25
National Security Council                         32, XXI
National Security Council and Office of Science   47, II
     and Technology Policy
National Telecommunications and Information       15, XXIII; 47, III
     Administration
National Transportation Safety Board              49, VIII
National Weather Service                          15, IX
Natural Resources Conservation Service            7, VI
Navajo and Hopi Indian Relocation, Office of      25, IV
Navy Department                                   32, VI
  Federal Acquisition Regulation                  48, 52
Neighborhood Reinvestment Corporation             24, XXV
Nuclear Regulatory Commission                     5, XLVIII; 10, I
  Federal Acquisition Regulation                  48, 20
Occupational Safety and Health Administration     29, XVII
Occupational Safety and Health Review Commission  29, XX
Offices of Independent Counsel                    28, VI
Operations Office                                 7, XXVIII
Overseas Private Investment Corporation           5, XXXIII; 22, VII
Panama Canal Commission                           48, 35
Panama Canal Regulations                          35, I
Patent and Trademark Office                       37, I
Payment From a Non-Federal Source for Travel      41, 304
     Expenses
Payment of Expenses Connected With the Death of   41, 303
     Certain Employees
Peace Corps                                       22, III
Pennsylvania Avenue Development Corporation       36, IX
Pension and Welfare Benefits Administration       29, XXV
Pension Benefit Guaranty Corporation              29, XL
Personnel Management, Office of                   5, I, XXXV; 45, VIII
  Federal Acquisition Regulation                  48, 17
  Federal Employees Group Life Insurance Federal  48, 21
       Acquisition Regulation
  Federal Employees Health Benefits Acquisition   48, 16
       Regulation
Postal Rate Commission                            5, XLVI; 39, III
Postal Service, United States                     5, LX; 39, I
Postsecondary Education, Office of                34, VI

[[Page 702]]

President's Commission on White House             1, IV
     Fellowships
Presidential Commission on the Assignment of      32, XXIX
     Women in the Armed Forces
Presidential Documents                            3
Prisons, Bureau of                                28, V
Productivity, Technology and Innovation,          37, IV
     Assistant Secretary
Public Contracts, Department of Labor             41, 50
Public and Indian Housing, Office of Assistant    24, IX
     Secretary for
Public Health Service                             42, I
Railroad Retirement Board                         20, II
Reclamation, Bureau of                            43, I
Refugee Resettlement, Office of                   45, IV
Regional Action Planning Commissions              13, V
Relocation Allowances                             41, 302
Research and Special Programs Administration      49, I
Rural Business-Cooperative Service                7, XVIII, XLII
Rural Development Administration                  7, XLII
Rural Housing Service                             7, XVIII, XXXV
Rural Telephone Bank                              7, XVI
Rural Utilities Service                           7, XVII, XVIII, XLII
Saint Lawrence Seaway Development Corporation     33, IV
Science and Technology Policy, Office of          32, XXIV
Science and Technology Policy, Office of, and     47, II
     National Security Council
Secret Service                                    31, IV
Securities and Exchange Commission                17, II
Selective Service System                          32, XVI
Small Business Administration                     13, I
Smithsonian Institution                           36, V
Social Security Administration                    20, III; 48, 23
Soldiers' and Airmen's Home, United States        5, XI
Special Counsel, Office of                        5, VIII
Special Education and Rehabilitative Services,    34, III
     Office of
Special Trustee for American Indians, Office of   25, VII
State Department                                  22, I
  Federal Acquisition Regulation                  48, 6
Surface Mining and Reclamation Appeals, Board of  30, III
Surface Mining Reclamation and Enforcement,       30, VII
     Office of
Surface Transportation Board                      49, X
Susquehanna River Basin Commission                18, VIII
Technology Administration                         15, XI
Technology Policy, Assistant Secretary for        37, IV
Technology, Under Secretary for                   37, V
Tennessee Valley Authority                        5, LXIX; 18, XIII
Thrift Depositor Protection Oversight Board       12, XV
Thrift Supervision Office, Department of the      12, V
     Treasury
Trade Representative, United States, Office of    15, XX
Transportation, Department of                     5, L
  Coast Guard                                     33, I; 46, I; 49, IV
  Commercial Space Transportation                 14, III
  Contract Appeals, Board of                      48, 63
  Emergency Management and Assistance             44, IV
  Federal Acquisition Regulation                  48, 12
  Federal Aviation Administration                 14, I
  Federal Highway Administration                  23, I, II; 49, III
  Federal Railroad Administration                 49, II
  Federal Transit Administration                  49, VI
  Maritime Administration                         46, II
  National Highway Traffic Safety Administration  23, II, III; 49, V
  Research and Special Programs Administration    49, I
  Saint Lawrence Seaway Development Corporation   33, IV
  Secretary of Transportation, Office of          14, II; 49, Subtitle A
  Surface Transportation Board                    49, X
Transportation, Office of                         7, XXXIII
Travel Allowances                                 41, 301
Treasury Department                               5, XXI; 17, IV
  Alcohol, Tobacco and Firearms, Bureau of        27, I

[[Page 703]]

  Community Development Financial Institutions    12, XVIII
       Fund
  Comptroller of the Currency                     12, I
  Customs Service, United States                  19, I
  Engraving and Printing, Bureau of               31, VI
  Federal Acquisition Regulation                  48, 10
  Federal Law Enforcement Training Center         31, VII
  Fiscal Service                                  31, II
  Foreign Assets Control, Office of               31, V
  Internal Revenue Service                        26, I
  International Investment, Office of             31, VIII
  Monetary Offices                                31, I
  Secret Service                                  31, IV
  Secretary of the Treasury, Office of            31, Subtitle A
  Thrift Supervision, Office of                   12, V
Truman, Harry S. Scholarship Foundation           45, XVIII
United States and Canada, International Joint     22, IV
     Commission
United States and Mexico, International Boundary  22, XI
     and Water Commission, United States Section
United States Enrichment Corporation              10, XI
Utah Reclamation Mitigation and Conservation      43, III
     Commission
Veterans Affairs Department                       38, I
  Federal Acquisition Regulation                  48, 8
Veterans' Employment and Training, Office of the  41, 61; 20, IX
     Assistant Secretary for
Vice President of the United States, Office of    32, XXVIII
Vocational and Adult Education, Office of         34, IV
Wage and Hour Division                            29, V
Water Resources Council                           18, VI
Workers' Compensation Programs, Office of         20, I
World Agricultural Outlook Board                  7, XXXVIII

[[Page 705]]

                                     

                                     



                   Table of OMB Control NumbersSecs. 



     PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Sec. 602.101  OMB Control numbers.

    (a) Purpose. This part collects and displays the control numbers 
assigned to collections of information in Internal Revenue Service 
regulations by the Office of Management and Budget (OMB) under the 
Paperwork Reduction Act of 1980. The Internal Revenue Service intends 
that this part (together with 26 CFR 601.9000) comply with the 
requirements of Secs. 1320.7(f), 1320.12, 1320.13, and 1320.14 of 5 CFR 
part 1320 (OMB regulations implementing the Paperwork Reduction Act), 
for the display of control numbers assigned by OMB to collections of 
information in Internal Revenue Service regulations. This part does not 
display control numbers assigned by the Office of Management and Budget 
to collections of information of the Bureau of Alcohol, Tobacco, and 
Firearms.
    (b) Cross-reference. For display of control numbers assigned by the 
Office of Management and Budget to Internal Revenue Service collections 
of information in the Statement of Procedural Rules (26 CFR part 601), 
see 26 CFR 601.9000.
    (c) Display.


------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
1.23-5.....................................................    1545-0074
1.25-1T....................................................    1545-0922
                                                               1545-0930
1.25-2T....................................................    1545-0922
                                                               1545-0930
1.25-3T....................................................    1545-0922
                                                               1545-0930
1.25-4T....................................................    1545-0922
1.25-5T....................................................    1545-0922
1.25-6T....................................................    1545-0922
1.25-7T....................................................    1545-0922
1.25-8T....................................................    1545-0922
1.28-1.....................................................    1545-0619
1.31-2.....................................................    1545-0074
1.32-2.....................................................    1545-0074
1.37-1.....................................................    1545-0074
1.37-3.....................................................    1545-0074
1.41-2.....................................................    1545-0619
1.41-3.....................................................    1545-0619
1.41-4A....................................................    1545-0074
1.41-4 (b) and (c).........................................    1545-0074
1.41-8(d)..................................................    1545-0732
1.41-9.....................................................    1545-0619
1.42-1T....................................................    1545-0984
                                                               1545-0988
1.42-2.....................................................    1545-1005
1.42-5.....................................................    1545-1291
1.42-6.....................................................    1545-1102
1.42-8.....................................................    1545-1102
1.42-10....................................................    1545-1102
1.42-13....................................................    1545-1357
1.42-14....................................................    1545-1423
1.43-3(a)(3)...............................................    1545-1292
1.43-3(b)(3)...............................................    1545-1292
1.44A-1....................................................    1545-0068
1.44A-3....................................................    1545-0074
1.44B-1....................................................    1545-0219
1.458-1....................................................    1545-0879
1.458-2....................................................    1545-0152
1.46-1.....................................................    1545-0123
                                                               1545-0155
1.46-3.....................................................    1545-0155
1.46-4.....................................................    1545-0155
1.46-5.....................................................    1545-0155
1.46-6.....................................................    1545-0155
1.46-8.....................................................    1545-0155
1.46-9.....................................................    1545-0155
1.46-10....................................................    1545-0118
1.46-11....................................................    1545-0155
1.47-1.....................................................    1545-0166
                                                               1545-0155
1.47-3.....................................................    1545-0166
                                                               1545-0155
1.47-4.....................................................    1545-0123
1.47-5.....................................................    1545-0092
1.47-6.....................................................    1545-0099
1.48-3.....................................................    1545-0155
1.48-4.....................................................    1545-0808
                                                               1545-0155
1.48-5.....................................................    1545-0155
1.48-6.....................................................    1545-0155
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1.263A-8(b)(2)(iii)........................................    1545-1265
1.263A-9(d)(1).............................................    1545-1265
1.263A-9(f)(1)(ii).........................................    1545-1265
1.263A-9(f)(2)(iv).........................................    1545-1265
1.263A-9(g)(2)(iv)(C)......................................    1545-1265
1.263A-9(g)(3)(iv).........................................    1545-1265
1.265-1....................................................    1545-0074
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1.367(a)-3T................................................    1545-0026
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1.402(f)-1.................................................    1545-1341
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1.410(a)-2.................................................    1545-0710
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1.411(d)-6T................................................    1545-1477
1.412(b)-5.................................................    1545-0710
1.412(c)(1)-2..............................................    1545-0710
1.412(c)(2)-1..............................................    1545-0710
1.412(c)(3)-2..............................................    1545-0710
1.414(c)-5.................................................    1545-0797
1.414(r)-1.................................................    1545-1221
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1.415-6....................................................    1545-0710
1.417(e)-1T................................................    1545-1471
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1.446-4(d).................................................    1545-1412
1.448-1(g).................................................    1545-0152
1.448-1(h).................................................    1545-0152
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1.453A-1...................................................    1545-0152
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1.468A-3...................................................    1545-1269
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1.468A-4...................................................    1545-0954
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1.468A-8...................................................    1545-1269
1.468B-1(j)................................................    1545-1299
1.468B-2(k)................................................    1545-1299
1.468B-2(l)................................................    1545-1299
1.468B-3(b)................................................    1545-1299
1.468B-3(e)................................................    1545-1299
1.468B-5(b)................................................    1545-1299
1.469-1....................................................    1545-1008
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1.475(b)-4.................................................    1545-1496
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1.501(c)(3)-1..............................................    1545-0056
1.501(c)(9)-5..............................................    1545-0047
1.501(c)(17)-3.............................................    1545-0047
1.501(e)-1.................................................    1545-0814
1.503(c)-1.................................................    1545-0047
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1.613A-3...................................................    1545-0919
1.613A-3(e)................................................    1545-1251
1.613A-3(l)................................................    1545-0919
1.613A-5...................................................    1545-0099
1.613A-6...................................................    1545-0099
1.614-2....................................................    1545-0099
1.614-3....................................................    1545-0099
1.614-5....................................................    1545-0099
1.614-6....................................................    1545-0099
1.614-8....................................................    1545-0099
1.617-1....................................................    1545-0099
1.617-3....................................................    1545-0099
1.617-4....................................................    1545-0099
1.631-1....................................................    1545-0007
1.631-2....................................................    1545-0007
1.641(b)-2.................................................    1545-0092
1.642(c)-1.................................................    1545-0092
1.642(c)-2.................................................    1545-0092
1.642(c)-5.................................................    1545-0074
1.642(c)-6.................................................    1545-0020
                                                               1545-0074
                                                               1545-0092
1.642(g)-1.................................................    1545-0092
1.642(i)-1.................................................    1545-0092
1.663(b)-2.................................................    1545-0092
1.664-1....................................................    1545-0196
1.664-2....................................................    1545-0196
1.664-3....................................................    1545-0196
1.664-4....................................................    1545-0020
                                                               1545-0196
1.665(a)-0A through                                                     
1.665(g)-2A................................................    1545-0192
1.666(d)-1A................................................    1545-0092
1.671-4....................................................    1545-1442
1.701-1....................................................    1545-0099
1.702-1....................................................    1545-0074
1.703-1....................................................    1545-0099
1.704-2....................................................    1545-1090
1.706-1....................................................    1545-0099
                                                               1545-0074
                                                               1545-0134
1.706-1T...................................................    1545-0099
1.707-3(c)(2)..............................................    1545-1243
1.707-5(a)(7)(ii)..........................................    1545-1243
1.707-6(c).................................................    1545-1243
1.707-8....................................................    1545-1243
1.708-1....................................................    1545-0099
1.732-1....................................................    1545-0099
1.736-1....................................................    1545-0074
1.743-1....................................................    1545-0074
1.751-1....................................................    1545-0074
                                                               1545-0099
                                                               1545-0941
1.752-5....................................................    1545-1090
1.754-1....................................................    1545-0099
1.755-1....................................................    1545-0099
1.755-2T...................................................    1545-1021
1.761-2....................................................    1545-1338
1.801-1....................................................    1545-0123
                                                               1545-0128
1.801-3....................................................    1545-0123
1.801-5....................................................    1545-0128
1.801-8....................................................    1545-0128
1.804-4....................................................    1545-0128
1.811-2....................................................    1545-0128
1.812-2....................................................    1545-0128
1.815-6....................................................    1545-0128
1.818-4....................................................    1545-0128
1.818-5....................................................    1545-0128
1.818-8....................................................    1545-0128
1.819-2....................................................    1545-0128
1.821-1....................................................    1545-1027
1.821-3....................................................    1545-1027
1.821-4....................................................    1545-1027

[[Page 710]]

                                                                        
1.822-5....................................................    1545-1027
1.822-6....................................................    1545-1027
1.822-8....................................................    1545-1027
1.822-9....................................................    1545-1027
1.823-2....................................................    1545-1027
1.823-5....................................................    1545-1027
1.823-6....................................................    1545-1027
1.825-1....................................................    1545-1027
1.826-1....................................................    1545-1027
1.826-2....................................................    1545-1027
1.826-3....................................................    1545-1027
1.826-4....................................................    1545-1027
1.826-6....................................................    1545-1027
1.831-3....................................................    1545-0123
1.831-4....................................................    1545-0123
1.832-4....................................................    1545-1227
1.832-5....................................................    1545-0123
1.848-2(g)(8)..............................................    1545-1287
1.848-2(h)(3)..............................................    1545-1287
1.848-2(i)(4)..............................................    1545-1287
1.851-2....................................................    1545-1010
1.851-4....................................................    1545-0123
1.852-1....................................................    1545-0123
1.852-4....................................................    1545-0123
                                                               1545-0145
1.852-6....................................................    1545-0123
                                                               1545-0144
1.852-7....................................................    1545-0074
1.852-9....................................................    1545-0074
                                                               1545-0123
                                                               1545-0144
                                                               1545-0145
1.852-11...................................................    1545-1094
1.853-3....................................................    1545-0123
1.853-4....................................................    1545-0123
1.854-2....................................................    1545-0123
1.855-1....................................................    1545-0123
1.856-2....................................................    1545-0123
                                                               1545-1004
1.856-6....................................................    1545-0123
1.856-7....................................................    1545-0123
1.856-8....................................................    1545-0123
1.857-8....................................................    1545-0123
1.857-9....................................................    1545-0074
1.858-1....................................................    1545-0123
1.860-2....................................................    1545-0045
1.860-4....................................................    1545-0045
                                                               1545-1054
                                                               1545-1057
1.860E-2(a)(5).............................................    1545-1276
1.860E-2(a)(7).............................................    1545-1276
1.860E-2(b)(2).............................................    1545-1276
1.861-2....................................................    1545-0089
1.861-3....................................................    1545-0089
1.861-8....................................................    1545-0126
1.861-8(e)(6) and (g)......................................    1545-1224
1.861-9T...................................................    1545-0121
                                                               1545-1072
1.863-1....................................................    1545-1476
1.863-3....................................................    1545-1467
1.863-3A...................................................    1545-0126
1.863-4....................................................    1545-0126
1.863-7....................................................    1545-0132
1.864-4....................................................    1545-0126
1.871-1....................................................    1545-0096
1.871-6....................................................    1545-0795
1.871-7....................................................    1545-0089
1.871-10...................................................    1545-0089
                                                               1545-0165
1.874-1....................................................    1545-0089
1.881-4....................................................    1545-1440
1.882-4....................................................    1545-0126
1.884-0....................................................    1545-1070
1.884-1....................................................    1545-1070
1.884-2....................................................    1545-1070
1.884-2T...................................................    1545-0126
                                                               1545-1070
1.884-4....................................................    1545-1070
1.884-5....................................................    1545-1070
1.892-1T...................................................    1545-1053
1.892-2T...................................................    1545-1053
1.892-3T...................................................    1545-1053
1.892-4T...................................................    1545-1053
1.892-5T...................................................    1545-1053
1.892-6T...................................................    1545-1053
1.892-7T...................................................    1545-1053
1.897-2....................................................    1545-0123
                                                               1545-0902
1.897-3....................................................    1545-0123
1.897-5T...................................................    1545-0902
1.897-6T...................................................    1545-0902
1.901-2....................................................    1545-0746
1.901-2A...................................................    1545-0746
1.901-3....................................................    1545-0122
1.902-1....................................................    1545-0122
                                                               1545-1458
1.904-1....................................................    1545-0121
                                                               1545-0122
1.904-2....................................................    1545-0121
                                                               1545-0122
1.904-3....................................................    1545-0121
1.904-4....................................................    1545-0121
1.904-5....................................................    1545-0121
1.904(f)-1.................................................    1545-0121
                                                               1545-0122
1.904(f)-2.................................................    1545-0121
1.904(f)-3.................................................    1545-0121
1.904(f)-4.................................................    1545-0121
1.904(f)-5.................................................    1545-0121
1.904(f)-6.................................................    1545-0121
1.904(f)-7.................................................    1545-1127
1.905-2....................................................    1545-0122
1.905-3T...................................................    1545-1056
1.905-4T...................................................    1545-1056
1.905-5T...................................................    1545-1056
1.911-1....................................................    1545-0067
                                                               1545-0070
1.911-2....................................................    1545-0067
                                                               1545-0070
1.911-3....................................................    1545-0067
                                                               1545-0070
1.911-4....................................................    1545-0067
                                                               1545-0070
1.911-5....................................................    1545-0067
                                                               1545-0070
1.911-6....................................................    1545-0067
                                                               1545-0070
1.911-7....................................................    1545-0067
                                                               1545-0070
1.913-13...................................................    1545-0067
1.921-1T...................................................    1545-0190
                                                               1545-0884
                                                               1545-0935
                                                               1545-0939
1.921-2....................................................    1545-0884
1.921-3T...................................................    1545-0935
1.923-1T...................................................    1545-0935
1.924(a)-1T................................................    1545-0935
1.925(a)-1T................................................    1545-0935
1.925(b)-1T................................................    1545-0935
1.926(a)-1T................................................    1545-0935
1.927(a)-1T................................................    1545-0935
1.927(b)-1T................................................    1545-0935
1.927(d)-1.................................................    1545-0884

[[Page 711]]

                                                                        
1.927(d)-2T................................................    1545-0935
1.927(e)-1T................................................    1545-0935
1.927(e)-2T................................................    1545-0935
1.927(f)-1.................................................    1545-0884
1.931-1....................................................    1545-0074
                                                               1545-0123
1.934-1....................................................    1545-0782
1.935-1....................................................    1545-0074
                                                               1545-0087
                                                               1545-0803
1.936-1....................................................    1545-0215
                                                               1545-0217
1.936-4....................................................    1545-0215
1.936-5....................................................    1545-0704
1.936-6....................................................    1545-0215
1.936-7....................................................    1545-0215
1.936-10(c)................................................    1545-1138
1.952-2....................................................    1545-0126
1.953-2....................................................    1545-0126
1.954-1....................................................    1545-1068
1.954-2....................................................    1545-1068
1.955-2....................................................    1545-0123
1.955-3....................................................    1545-0123
1.955A-2...................................................    1545-0755
1.955A-3...................................................    1545-0755
1.956-1....................................................    1545-0704
1.956-2....................................................    1545-0704
1.959-1....................................................    1545-0704
1.959-2....................................................    1545-0704
1.960-1....................................................    1545-0122
1.962-2....................................................    1545-0704
1.962-3....................................................    1545-0704
1.962-4....................................................    1545-0704
1.964-1....................................................    1545-0126
                                                               1545-0704
                                                               1545-1072
1.964-3....................................................    1545-0126
1.970-2....................................................    1545-0126
1.985-2....................................................    1545-1051
                                                               1545-1131
1.985-3....................................................    1545-1051
1.988-0....................................................    1545-1131
1.988-1....................................................    1545-1131
1.988-2....................................................    1545-1131
1.988-3....................................................    1545-1131
1.988-4....................................................    1545-1131
1.988-5....................................................    1545-1131
1.992-1....................................................    1545-0190
                                                               1545-0938
1.992-2....................................................    1545-0190
                                                               1545-0884
                                                               1545-0938
1.992-3....................................................    1545-0190
                                                               1545-0938
1.992-4....................................................    1545-0190
                                                               1545-0938
1.993-3....................................................    1545-0938
1.993-4....................................................    1545-0938
1.994-1....................................................    1545-0938
1.995-5....................................................    1545-0938
1.1012-1...................................................    1545-0074
                                                               1545-1139
1.1014-4...................................................    1545-0184
1.1015-1...................................................    1545-0020
1.1017-2...................................................    1545-0028
                                                               1545-0046
1.1031(d)-1T...............................................    1545-1021
1.1033(a)-2................................................    1545-0184
1.1033(g)-1................................................    1545-0184
1.1034-1...................................................    1545-0072
1.1039-1...................................................    1545-0184
1.1041-1T..................................................    1545-0074
1.1042-1T..................................................    1545-0916
1.1044(a)-1................................................    1545-1421
1.1060-1T..................................................    1545-1021
1.1071-1...................................................    1545-0184
1.1071-4...................................................    1545-0184
1.1081-4...................................................    1545-0028
                                                               1545-0046
                                                               1545-0123
1.1081-11..................................................    1545-0074
                                                               1545-0123
1.1082-1...................................................    1545-0046
1.1082-2...................................................    1545-0046
1.1082-3...................................................    1545-0046
                                                               1545-0184
1.1082-4...................................................    1545-0046
1.1082-5...................................................    1545-0046
1.1082-6...................................................    1545-0046
1.1083-1...................................................    1545-0123
1.1092(b)-1T...............................................    1545-0644
1.1092(b)-2T...............................................    1545-0644
1.1092(b)-3T...............................................    1545-0644
1.1092(b)-4T...............................................    1545-0644
1.1092(b)-5T...............................................    1545-0644
1.1211-1...................................................    1545-0074
1.1212-1...................................................    1545-0074
1.1221-2...................................................    1545-1403
1.1221-2(d)(2)(iv).........................................    1545-1480
1.1221-2(e)(5).............................................    1545-1480
1.1221-2(g)(5)(ii).........................................    1545-1480
1.1221-2(g)(6)(ii).........................................    1545-1480
1.1221-2(g)(6)(iii)........................................    1545-1480
1.1221-2T(c)...............................................    1545-1403
1.1231-1...................................................    1545-0177
                                                               1545-0184
1.1231-2...................................................    1545-0177
                                                               1545-0184
1.1231-2...................................................    1545-0074
1.1232-3...................................................    1545-0074
1.1237-1...................................................    1545-0184
1.1239-1...................................................    1545-0091
1.1242-1...................................................    1545-0184
1.1243-1...................................................    1545-0123
1.1244(e)-1................................................    1545-0123
                                                               1545-1447
1.1245-1...................................................    1545-0184
1.1245-2...................................................    1545-0184
1.1245-3...................................................    1545-0184
1.1245-4...................................................    1545-0184
1.1245-5...................................................    1545-0184
1.1245-6...................................................    1545-0184
1.1247-1...................................................    1545-0122
1.1247-2...................................................    1545-0122
1.1247-4...................................................    1545-0122
1.1247-5...................................................    1545-0122
1.1248-7...................................................    1545-0074
1.1250-1...................................................    1545-0184
1.1250-2...................................................    1545-0184
1.1250-3...................................................    1545-0184
1.1250-4...................................................    1545-0184
1.1250-5...................................................    1545-0184
1.1251-1...................................................    1545-0184
1.1251-2...................................................    1545-0074
                                                               1545-0184
1.1251-3...................................................    1545-0184
1.1251-4...................................................    1545-0184
1.1252-1...................................................    1545-0184
1.1252-2...................................................    1545-0184
1.1254-1(c)(3).............................................    1545-1352
1.1254-4...................................................    1545-1493
1.1254-5(d)(2).............................................    1545-1352
1.1258-1...................................................    1545-1452
1.1272-3...................................................    1545-1353

[[Page 712]]

                                                                        
1.1273-2(h)(2).............................................    1545-1353
1.1274-3(d)................................................    1545-1353
1.1274-5(b)................................................    1545-1353
1.1274A-1(c)...............................................    1545-1353
1.1275-2...................................................    1545-1450
1.1275-3...................................................    1545-0887
                                                               1545-1353
                                                               1545-1450
1.1275-4...................................................    1545-1450
1.1275-6...................................................    1545-1450
1.1287-1...................................................    1545-0786
1.1291-9...................................................    1545-1507
1.1291-10..................................................    1545-1507
                                                               1545-1304
1.1294-1T..................................................    1545-1002
                                                               1545-1028
1.1295-1T..................................................    1545-1028
1.1297-3T..................................................    1545-1028
1.1311(a)-1................................................    1545-0074
1.1361-1...................................................    1545-0731
1.1362-1...................................................    1545-1308
1.1362-2...................................................    1545-1308
1.1362-3...................................................    1545-1308
1.1362-4...................................................    1545-1308
1.1362-5...................................................    1545-1308
1.1362-6...................................................    1545-1308
1.1362-7...................................................    1545-1308
1.1367-1(f)................................................    1545-1139
1.1368-1(f)(2).............................................    1545-1139
1.1368-1(f)(3).............................................    1545-1139
1.1368-1(f)(4).............................................    1545-1139
1.1368-1(g)(2).............................................    1545-1139
1.1374-1A..................................................    1545-0130
1.1377-1...................................................    1545-1462
1.1383-1...................................................    1545-0074
1.1385-1...................................................    1545-0074
                                                               1545-0098
1.1388-1...................................................    1545-0118
                                                               1545-0123
1.1398-1...................................................    1545-1375
1.1398-2...................................................    1545-1375
1.1402(a)-2................................................    1545-0074
1.1402(a)-5................................................    1545-0074
1.1402(a)-11...............................................    1545-0074
1.1402(a)-15...............................................    1545-0074
1.1402(a)-16...............................................    1545-0074
1.1402(b)-1................................................    1545-0171
1.1402(c)-2................................................    1545-0074
1.1402(e)(1)-1.............................................    1545-0074
1.1402(e)(2)-1.............................................    1545-0074
1.1402(e)-1A...............................................    1545-0168
1.1402(e)-2A...............................................    1545-0168
1.1402(e)-3A...............................................    1545-0168
1.1402(e)-4A...............................................    1545-0168
1.1402(e)-5A...............................................    1545-0168
1.1402(f)-1................................................    1545-0074
1.1402(h)-1................................................    1545-0064
1.1441-2...................................................    1545-0795
1.1441-3...................................................    1545-0165
                                                               1545-0795
1.1441-5...................................................    1545-0096
                                                               1545-0795
1.1441-6...................................................    1545-0055
                                                               1545-0795
1.1441-7...................................................    1545-0795
1.1441-8T..................................................    1545-1053
1.1443-1...................................................    1545-0096
1.1445-1...................................................    1545-0902
1.1445-2...................................................    1545-0902
                                                               1545-1060
1.1445-3...................................................    1545-0902
                                                               1545-1060
1.1445-4...................................................    1545-0902
1.1445-5...................................................    1545-0902
1.1445-6...................................................    1545-0902
                                                               1545-1060
1.1445-7...................................................    1545-0902
1.1445-8...................................................    1545-0096
1.1445-9T..................................................    1545-0902
1.1445-10T.................................................    1545-0902
1.1451-1...................................................    1545-0054
1.1451-2...................................................    1545-0054
1.1461-1...................................................    1545-0054
                                                               1545-0055
                                                               1545-0795
1.1461-2...................................................    1545-0054
                                                               1545-0055
                                                               1545-0096
                                                               1545-0795
1.1461-3...................................................    1545-0054
                                                               1545-0055
                                                               1545-0096
                                                               1545-0795
1.1461-4...................................................    1545-0054
                                                               1545-0055
                                                               1545-0096
1.1462-1...................................................    1545-0795
1.1492-1...................................................    1545-0026
1.1494-1...................................................    1545-0026
1.1502-5...................................................    1545-0257
1.1502-9...................................................    1545-0121
1.1502-13..................................................    1545-0123
                                                               1545-0885
                                                               1545-1161
                                                               1545-1433
1.1502-16..................................................    1545-0123
1.1502-18..................................................    1545-0123
1.1502-19..................................................    1545-0123
1.1502-20..................................................    1545-1160
1.1502-21T.................................................    1545-1237
1.1502-31..................................................    1545-1344
1.1502-32..................................................    1545-1344
1.1502-33..................................................    1545-1344
1.1502-47..................................................    1545-0123
1.1502-75..................................................    1545-0025
                                                               1545-0123
                                                               1545-0133
                                                               1545-0152
1.1502-76..................................................    1545-1344
1.1502-77..................................................    1545-0123
1.1502-77T.................................................    1545-1046
1.1502-78..................................................    1545-0582
1.1502-95T.................................................    1545-1218
1.1503-2A..................................................    1545-1083
1.1552-1...................................................    1545-0123
1.1561-3...................................................    1545-0123
1.1563-1...................................................    1545-0123
                                                               1545-0797
1.1563-3...................................................    1545-0123
1.6001-1...................................................    1545-0058
                                                               1545-0074
                                                               1545-0099
                                                               1545-0123
                                                               1545-0865
1.6011-1...................................................    1545-0055
                                                               1545-0074
                                                               1545-0085
                                                               1545-0089
                                                               1545-0090
                                                               1545-0091
                                                               1545-0096
                                                               1545-0121
                                                               1545-0458
                                                               1545-0666

[[Page 713]]

                                                                        
                                                               1545-0675
                                                               1545-0908
1.6011-2...................................................    1545-0055
                                                               1545-0938
1.6011-3...................................................    1545-0238
                                                               1545-0239
1.6012-1...................................................    1545-0067
                                                               1545-0085
                                                               1545-0089
                                                               1545-0675
                                                               1545-0074
1.6012-2...................................................    1545-0047
                                                               1545-0051
                                                               1545-0067
                                                               1545-0123
                                                               1545-0126
                                                               1545-0130
                                                               1545-0128
                                                               1545-0175
                                                               1545-0687
                                                               1545-0890
                                                               1545-1023
                                                               1545-1027
1.6012-3...................................................    1545-0047
                                                               1545-0067
                                                               1545-0092
                                                               1545-0196
                                                               1545-0687
1.6012-4...................................................    1545-0067
1.6012-5...................................................    1545-0067
                                                               1545-0967
                                                               1545-0970
                                                               1545-0991
                                                               1545-0936
                                                               1545-1023
                                                               1545-1033
                                                               1545-1079
1.6012-6...................................................    1545-0067
1.6012-7T..................................................    1545-1348
                                                               1545-0089
                                                               1545-0129
1.6013-1...................................................    1545-0074
1.6013-2...................................................    1545-0091
1.6013-6...................................................    1545-0074
1.6013-7...................................................    1545-0074
1.6015(a)-1................................................    1545-0087
1.6015(b)-1................................................    1545-0087
1.6015(d)-1................................................    1545-0087
1.6015(e)-1................................................    1545-0087
1.6015(f)-1................................................    1545-0087
1.6015(g)-1................................................    1545-0087
1.6015(h)-1................................................    1545-0087
1.6015(i)-1................................................    1545-0087
1.6017-1...................................................    1545-0074
                                                               1545-0087
                                                               1545-0090
1.6031(b)-1T...............................................    1545-0099
1.6031(c)-1T...............................................    1545-0099
1.6031-1...................................................    1545-0099
                                                               1545-0970
1.6032-1...................................................    1545-0099
1.6033-2...................................................    1545-0047
                                                               1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0687
                                                               1545-1150
1.6033-3...................................................    1545-0052
1.6034-1...................................................    1545-0092
                                                               1545-0094
1.6035-1...................................................    1545-0704
1.6035-2...................................................    1545-0704
1.6035-3...................................................    1545-0704
1.6037-1...................................................    1545-0130
                                                               1545-1023
1.6038-2...................................................    1545-0704
                                                               1545-0805
                                                               1545-1317
1.6038A-2..................................................    1545-1191
1.6038A-3..................................................    1545-1191
                                                               1545-1440
1.6038B-1T.................................................    1545-0026
1.6039-2...................................................    1545-0820
1.6041-1...................................................    1545-0008
                                                               1545-0108
                                                               1545-0112
                                                               1545-0115
                                                               1545-0120
                                                               1545-0295
                                                               1545-0350
                                                               1545-0367
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
1.6041-2...................................................    1545-0008
                                                               1545-0119
                                                               1545-0350
                                                               1545-0441
1.6041-3...................................................    1545-1148
1.6041-4...................................................    1545-0115
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6041-5...................................................    1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6041-6...................................................    1545-0008
                                                               1545-0115
1.6041-7...................................................    1545-0112
                                                               1545-0295
                                                               1545-0350
                                                               1545-0367
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
1.6042-1...................................................    1545-0110
1.6042-2...................................................    1545-0110
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6042-3...................................................    1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
1.6042-4...................................................    1545-0110
1.6043-1...................................................    1545-0041
1.6043-2...................................................    1545-0041
                                                               1545-0110
                                                               1545-0295
                                                               1545-0387
1.6043-3...................................................    1545-0047
1.6044-1...................................................    1545-0118
1.6044-2...................................................    1545-0118
1.6044-3...................................................    1545-0118
1.6044-4...................................................    1545-0118
1.6044-5...................................................    1545-0118
1.6045-1...................................................    1545-0715
1.6045-2...................................................    1545-0115
1.6045-4...................................................    1545-1085
1.6046-1...................................................    1545-0704
                                                               1545-0794

[[Page 714]]

                                                                        
                                                               1545-1317
1.6046-2...................................................    1545-0704
1.6046-3...................................................    1545-0704
1.6047-1...................................................    1545-0119
                                                               1545-0295
                                                               1545-0387
1.6049-1...................................................    1545-0112
                                                               1545-0117
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0597
                                                               1545-0957
1.6049-2...................................................    1545-0117
1.6049-3...................................................    1545-0117
1.6049-4...................................................    1545-0096
                                                               1545-0112
                                                               1545-0117
                                                               1545-1018
                                                               1545-1050
1.6049-5...................................................    1545-0096
                                                               1545-0112
                                                               1545-0117
1.6049-6...................................................    1545-0096
1.6049-7...................................................    1545-1018
1.6049-7T..................................................    1545-0112
                                                               1545-0117
                                                               1545-0118
1.6050A-1..................................................    1545-0115
1.6050B-1..................................................    1545-0120
1.6050D-1..................................................    1545-0120
                                                               1545-0232
1.6050E-1..................................................    1545-0120
1.6050H-1..................................................    1545-0901
                                                               1545-1380
1.6050H-2..................................................    1545-0901
                                                               1545-1339
                                                               1545-1380
1.6050H-1T.................................................    1545-0901
1.6050I-2..................................................    1545-1449
1.6050J-1T.................................................    1545-0877
1.6050K-1..................................................    1545-0941
1.6050P-1..................................................    1545-1419
1.6050P-1T.................................................    1545-1419
1.6052-1...................................................    1545-0008
1.6052-2...................................................    1545-0008
1.6060-1...................................................    1545-0074
1.6061-1...................................................    1545-0123
1.6061-2T..................................................    1545-1348
1.6062-1...................................................    1545-0123
1.6063-1...................................................    1545-0123
1.6065-1...................................................    1545-0123
1.6071-1...................................................    1545-0123
                                                               1545-0810
1.6072-1...................................................    1545-0074
1.6072-2...................................................    1545-0123
                                                               1545-0807
1.6073-1...................................................    1545-0087
1.6073-2...................................................    1545-0087
1.6073-3...................................................    1545-0087
1.6073-4...................................................    1545-0087
1.6074-1...................................................    1545-0123
1.6074-2...................................................    1545-0123
1.6081-1...................................................    1545-0066
                                                               1545-0148
                                                               1545-0233
                                                               1545-1057
                                                               1545-1081
1.6081-2...................................................    1545-0148
                                                               1545-1054
                                                               1545-1036
1.6081-3...................................................    1545-0233
1.6081-4...................................................    1545-0188
                                                               1545-1479
6081-6.....................................................    1545-0148
                                                               1545-1054
6081-7.....................................................    1545-0148
                                                               1545-1054
1.6091-3...................................................    1545-0089
1.6107-1...................................................    1545-0074
1.6109-1...................................................    1545-0074
1.6109-2...................................................    1545-0074
1.6115-1...................................................    1545-1464
1.6151-1...................................................    1545-0074
1.6152-1...................................................    1545-0135
                                                               1545-0233
1.6153-1...................................................    1545-0087
1.6153-4...................................................    1545-0087
1.6154-2...................................................    1545-0257
1.6154-3...................................................    1545-0135
1.6154-5...................................................    1545-0976
1.6161-1...................................................    1545-0087
1.6162-1...................................................    1545-0087
1.6164-1...................................................    1545-0135
1.6164-2...................................................    1545-0135
1.6164-3...................................................    1545-0135
1.6164-5...................................................    1545-0135
1.6164-6...................................................    1545-0135
1.6164-7...................................................    1545-0135
1.6164-8...................................................    1545-0135
1.6164-9...................................................    1545-0135
1.6302-1...................................................    1545-0257
1.6302-2...................................................    1545-0098
                                                               1545-0257
1.6411-1...................................................    1545-0098
                                                               1545-0135
                                                               1545-0582
1.6411-2...................................................    1545-0098
                                                               1545-0582
1.6411-3...................................................    1545-0098
                                                               1545-0582
1.6411-4...................................................    1545-0582
1.6414-1...................................................    1545-0096
1.6425-1...................................................    1545-0170
1.6425-2...................................................    1545-0170
1.6425-3...................................................    1545-0170
1.6654-1...................................................    1545-0087
                                                               1545-0140
1.6654-2...................................................    1545-0087
1.6654-3...................................................    1545-0087
1.6654-4...................................................    1545-0087
1.6655-1...................................................    1545-0142
1.6655-2...................................................    1545-0142
1.6655-3...................................................    1545-0142
1.6655-7...................................................    1545-0123
1.6655(e)-1................................................    1545-1421
1.6661-3...................................................    1545-0988
                                                               1545-1031
1.6661-4...................................................    1545-0739
1.6662-3(c)................................................    1545-0889
1.6662-4(e) and (f)........................................    1545-0889
1.6662-6...................................................    1545-1426
1.6694-1...................................................    1545-0074
1.6694-2...................................................    1545-0074
1.6694-2(c)................................................    1545-1231
1.6694-3(e)................................................    1545-1231
1.6695-1...................................................    1545-0074
                                                               1545-1385
1.6696-1...................................................    1545-0074
                                                               1545-0240
1.6851-1...................................................    1545-0086
                                                               1545-0138
1.6851-2...................................................    1545-0086
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[[Page 715]]

                                                                        
1.7476-1...................................................    1545-0197
1.7476-2...................................................    1545-0197
1.7519-2T..................................................    1545-1036
1.7520-1...................................................    1545-1343
1.7520-2...................................................    1545-1343
1.7520-3...................................................    1545-1343
1.7520-4...................................................    1545-1343
1.9100-1...................................................    1545-0074
1.9101-1...................................................    1545-0008
2.1-4......................................................    1545-0123
2.1-5......................................................    1545-0123
2.1-6......................................................    1545-0123
2.1-10.....................................................    1545-0123
2.1-11.....................................................    1545-0123
2.1-12.....................................................    1545-0123
2.1-13.....................................................    1545-0123
2.1-20.....................................................    1545-0123
2.1-22.....................................................    1545-0123
2.1-26.....................................................    1545-0123
3.2........................................................    1545-0123
4.954-1....................................................    1545-1068
4.954-2....................................................    1545-1068
5.6411-1...................................................    1545-0098
                                                               1545-0582
                                                               1545-0042
                                                               1545-0074
                                                               1545-0129
                                                               1545-0172
                                                               1545-0619
5c.44F-1...................................................    1545-0619
5c.128-1...................................................    1545-0123
5c.168(f)(8)-1.............................................    1545-0123
5c.168(f)(8)-2.............................................    1545-0123
5c.168(f)(8)-6.............................................    1545-0123
5c.168(f)(8)-8.............................................    1545-0123
5c.305-1...................................................    1545-0110
5c.442-1...................................................    1545-0152
5f.103-1...................................................    1545-0720
5f.103-3...................................................    1545-0720
5f.6045-1..................................................    1545-0715
6a.103A-2..................................................    1545-0123
                                                               1545-0720
6a.103A-3..................................................    1545-0720
7.367(b)-1.................................................    1545-0026
7.367(b)-3.................................................    1545-0026
7.367(b)-7.................................................    1545-0026
7.367(b)-9.................................................    1545-0026
7.367(b)-10................................................    1545-0026
7.465-1....................................................    1545-0712
7.465-2....................................................    1545-0712
7.465-3....................................................    1545-0712
7.465-4....................................................    1545-0712
7.465-5....................................................    1545-0712
7.936-1....................................................    1545-0217
7.999-1....................................................    1545-0216
7.6039A-1..................................................    1545-0015
7.6041-1...................................................    1545-0115
11.410-1...................................................    1545-0710
11.412(c)-7................................................    1545-0710
11.412(c)-11...............................................    1545-0710
12.7.......................................................    1545-0190
12.8.......................................................    1545-0191
12.9.......................................................    1545-0195
14a.422A-1.................................................    1545-0123
15A.453-1..................................................    1545-0228
16.3-1.....................................................    1545-0159
16A.126-2..................................................    1545-0074
16A.1255-1.................................................    1545-0184
16A.1255-2.................................................    1545-0184
18.1371-1..................................................    1545-0130
18.1378-1..................................................    1545-0130
18.1379-1..................................................    1545-0130
18.1379-2..................................................    1545-0130
20.2011-1..................................................    1545-0015
20.2014-5..................................................    1545-0015
                                                               1545-0260
20.2014-6..................................................    1545-0015
20.2016-1..................................................    1545-0015
20.2031-2..................................................    1545-0015
20.2031-3..................................................    1545-0015
20.2031-4..................................................    1545-0015
20.2031-6..................................................    1545-0015
20.2031-7..................................................    1545-0020
20.2031-10.................................................    1545-0015
20.2032-1..................................................    1545-0015
20.2032A-3.................................................    1545-0015
20.2032A-4.................................................    1545-0015
20.2032A-8.................................................    1545-0015
20.2039-4..................................................    1545-0015
20.2051-1..................................................    1545-0015
20.2053-3..................................................    1545-0015
20.2053-9..................................................    1545-0015
20.2053-10.................................................    1545-0015
20.2055-1..................................................    1545-0015
20.2055-2..................................................    1545-0015
                                                               1545-0092
20.2055-3..................................................    1545-0015
20.2056(b)-4...............................................    1545-0015
20.2056(b)-7...............................................    1545-0015
20.2056A-2.................................................    1545-1443
20.2056A-3.................................................    1545-1360
20.2056A-4.................................................    1545-1360
20.2056A-10................................................    1545-1360
20.2106-1..................................................    1545-0015
20.2106-2..................................................    1545-0015
20.2204-1..................................................    1545-0015
20.2204-2..................................................    1545-0015
20.6001-1..................................................    1545-0015
20.6011-1..................................................    1545-0015
20.6018-1..................................................    1545-0015
                                                               1545-0531
20.6018-2..................................................    1545-0015
20.6018-3..................................................    1545-0015
20.6018-4..................................................    1545-0015
                                                               1545-0022
20.6036-2..................................................    1545-0015
20.6061-1..................................................    1545-0015
20.6065-1..................................................    1545-0015
20.6075-1..................................................    1545-0015
20.6081-1..................................................    1545-0015
                                                               1545-0181
20.6091-1..................................................    1545-0015
20.6161-1..................................................    1545-0015
                                                               1545-0181
20.6161-2..................................................    1545-0015
                                                               1545-0181
20.6163-1..................................................    1545-0015
20.6166-1..................................................    1545-0181
20.6166A-1.................................................    1545-0015
20.6166A-3.................................................    1545-0015
20.6324A-1.................................................    1545-0754
20.7520-1..................................................    1545-1343
20.7520-2..................................................    1545-1343
20.7520-3..................................................    1545-1343
20.7520-4..................................................    1545-1343
22.0.......................................................    1545-0015
25.2511-2..................................................    1545-0020
25.2512-2..................................................    1545-0020
25.2512-3..................................................    1545-0020
25.2512-5..................................................    1545-0020
25.2512-9..................................................    1545-0020
25.2513-1..................................................    1545-0020
25.2513-2..................................................    1545-0020
                                                               1545-0021

[[Page 716]]

                                                                        
25.2513-3..................................................    1545-0020
25.2518-2..................................................    1545-0959
25.2522(a)-1...............................................    1545-0196
25.2522(c)-3...............................................    1545-0020
                                                               1545-0196
25.2523(a)-1...............................................    1545-0020
                                                               1545-0196
25.2523(f)-1...............................................    1545-0015
25.2701-2..................................................    1545-1241
25.2701-4..................................................    1545-1241
25.2701-5..................................................    1545-1273
25.2702-6..................................................    1545-1273
25.6001-1..................................................    1545-0020
                                                               1545-0022
25.6011-1..................................................    1545-0020
25.6019-1..................................................    1545-0020
25.6019-2..................................................    1545-0020
25.6019-3..................................................    1545-0020
25.6019-4..................................................    1545-0020
25.6061-1..................................................    1545-0020
25.6065-1..................................................    1545-0020
25.6075-1..................................................    1545-0020
25.6081-1..................................................    1545-0020
25.6091-1..................................................    1545-0020
25.6091-2..................................................    1545-0020
25.6151-1..................................................    1545-0020
25.6161-1..................................................    1545-0020
25.7520-1..................................................    1545-1343
25.7520-2..................................................    1545-1343
25.7520-3..................................................    1545-1343
25.7520-4..................................................    1545-1343
26.2601-1..................................................    1545-0985
26.2632-1..................................................    1545-0985
26.2642-1..................................................    1545-0985
26.2642-2..................................................    1545-0985
26.2642-3..................................................    1545-0985
26.2642-4..................................................    1545-0985
26.2652-2..................................................    1545-0985
26.2662-1..................................................    1545-0015
                                                               1545-0985
26.2662-2..................................................    1545-0985
31.3102-3..................................................    1545-0029
                                                               1545-0059
                                                               1545-0065
31.3121(b)(19)-1...........................................    1545-0029
31.3121(d)-1...............................................    1545-0004
31.3121(i)-1...............................................    1545-0034
31.3121(k)-4...............................................    1545-0137
31.3121(r)-1...............................................    1545-0029
31.3121(s)-1...............................................    1545-0029
31.3302(a)-2...............................................    1545-0028
31.3302(a)-3...............................................    1545-0028
31.3302(b)-2...............................................    1545-0028
31.3302(e)-1...............................................    1545-0028
31.3306(c)(18)-1...........................................    1545-0029
31.3401(a)-1...............................................    1545-0029
31.3401(a)(6)-1............................................    1545-0029
                                                               1545-0096
                                                               1545-0795
31.3401(a)(7)-1............................................    1545-0029
31.3401(a)(8)(A)-1 ........................................    1545-0029
                                                               1545-0666
31.3401(a)(8)(C)-1 ........................................    1545-0029
31.3401(a)(15)-1...........................................    1545-0182
31.3401(c)-1...............................................    1545-0004
31.3402(b)-1...............................................    1545-0010
31.3402(c)-1...............................................    1545-0010
31.3402(f)(1)-1............................................    1545-0010
31.3402(f)(2)-1............................................    1545-0010
                                                               1545-0410
31.3402(f)(3)-1............................................    1545-0010
31.3402(f)(4)-1............................................    1545-0010
31.3402(f)(4)-2............................................    1545-0010
31.3402(f)(5)-1............................................    1545-0010
                                                               1545-1435
31.3402(h)(1)-1............................................    1545-0029
31.3402(h)(3)-1............................................    1545-0010
31.3402(h)(3)-1............................................    1545-0029
31.3402(h)(4)-1............................................    1545-0010
31.3402(i)-(1).............................................    1545-0010
31.3402(i)-(2).............................................    1545-0010
31.3402(k)-1...............................................    1545-0065
31.3402(l)-(1).............................................    1545-0010
31.3402(m)-(1).............................................    1545-0010
31.3402(n)-(1).............................................    1545-0010
31.3402(o)-2...............................................    1545-0415
31.3402(o)-3...............................................    1545-0008
                                                               1545-0010
                                                               1545-0415
                                                               1545-0717
31.3402(p)-1...............................................    1545-0415
                                                               1545-0717
31.3402(q)-1...............................................    1545-0238
                                                               1545-0239
31.3404-1..................................................    1545-0029
31.3405(c)-1...............................................    1545-1341
31.3406(a)-1...............................................    1545-0112
31.3406(a)-2...............................................    1545-0112
31.3406(a)-3...............................................    1545-0112
31.3406(a)-4...............................................    1545-0112
31.3406(b)(2)-1............................................    1545-0112
31.3406(b)(2)-2............................................    1545-0112
31.3406(b)(2)-3............................................    1545-0112
31.3406(b)(2)-4............................................    1545-0112
31.3406(b)(2)-5............................................    1545-0112
31.3406(b)(3)-1............................................    1545-0112
31.3406(b)(3)-2............................................    1545-0112
31.3406(b)(3)-3............................................    1545-0112
31.3406(b)(3)-4............................................    1545-0112
31.3406(b)(4)-1............................................    1545-0112
31.3406(c)-1...............................................    1545-0112
31.3406(d)-1...............................................    1545-0112
31.3406(d)-2...............................................    1545-0112
31.3406(d)-3...............................................    1545-0112
31.3406(d)-4...............................................    1545-0112
31.3406(d)-5...............................................    1545-0112
31.3406(e)-1...............................................    1545-0112
31.3406(f)-1...............................................    1545-0112
31.3406(g)-1...............................................    1545-0096
                                                               1545-0112
31.3406(g)-2...............................................    1545-0112
31.3406(g)-3...............................................    1545-0112
31.3406(h)-1...............................................    1545-0112
31.3406(h)-2...............................................    1545-0112
31.3406(h)-3...............................................    1545-0112
31.3406(i)-1...............................................    1545-0112
31.3501(a)-1T..............................................    1545-0771
31.3503-1..................................................    1545-0024
31.3504-1..................................................    1545-0029
31.6001-1..................................................    1545-0798
31.6001-2..................................................    1545-0034
                                                               1545-0798
31.6001-3..................................................    1545-0798
31.6001-4..................................................    1545-0028
31.6001-5..................................................    1545-0798
31.6001-6..................................................    1545-0029
                                                               1459-0798
31.6011(a)-1...............................................    1545-0029
                                                               1545-0034
                                                               1545-0035
                                                               1545-0059
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31.6011(a)-2...............................................    1545-0001
                                                               1545-0002
31.6011(a)-3...............................................    1545-0028
31.6011(a)-3A..............................................    1545-0955
31.6011(a)-4...............................................    1545-0034
                                                               1545-0035
                                                               1545-0718
                                                               1545-1413
31.6011(a)-5...............................................    1545-0718
                                                               1545-0028
31.6011(a)-6...............................................    1545-0028
31.6011(a)-7...............................................    1545-0074
31.6011(a)-8...............................................    1545-0028
31.6011(a)-9...............................................    1545-0028
31.6011(a)-10..............................................    1545-0112
31.6011(b)-1...............................................    1545-0003
31.6011(b)-2...............................................    1545-0029
31.6051-1..................................................    1545-0008
                                                               1545-0182
                                                               1545-0458
31.6051-2..................................................    1545-0008
31.6051-3..................................................    1545-0008
31.6053-1..................................................    1545-0029
                                                               1545-0062
                                                               1545-0064
                                                               1545-0065
31.6053-2..................................................    1545-0008
31.6053-3..................................................    1545-0065
                                                               1545-0714
31.6053-4..................................................    1545-0065
31.6065(a)-1...............................................    1545-0029
31.6071(a)-1...............................................    1545-0001
                                                               1545-0028
                                                               1545-0029
31.6071(a)-1A..............................................    1545-0955
31.6081(a)-1...............................................    1545-0008
                                                               1545-0028
31.6091-1..................................................    1545-0028
                                                               1545-0029
31.6157-1..................................................    1545-0955
31.6205-1..................................................    1545-0029
31.6301(c)-1AT.............................................    1545-0035
                                                               1545-0112
                                                               1545-0257
31.6302-1..................................................    1545-1413
31.6302-2..................................................    1545-1413
31.6302-3..................................................    1545-1413
31.6302-4..................................................    1545-1413
31.6302(c)-2...............................................    1545-0001
                                                               1545-0257
31.6302(c)-2A..............................................    1545-0955
31.6302(c)-3...............................................    1545-0257
31.6402(a)-2...............................................    1545-0256
31.6413(a)-1...............................................    1545-0029
31.6413(a)-2...............................................    1545-0029
                                                               1545-0256
31.6413(c)-1...............................................    1545-0029
                                                               1545-0171
31.6414-1..................................................    1545-0029
32.1.......................................................    1545-0029
                                                               1545-0415
32.2.......................................................    1545-0029
35a.3406-2.................................................    1545-0112
35a.9999-3.................................................    1545-0112
35a.9999-5.................................................    1545-0029
36.3121(l)(1)-1............................................    1545-0137
36.3121(l)(1)-2............................................    1545-0137
36.3121(l)(3)-1............................................    1545-0123
36.3121(1)(7)-1............................................    1545-0123
36.3121(1)(10)-1...........................................    1545-0029
36.3121(1)(10)-3...........................................    1545-0029
36.3121(1)(10)-4...........................................    1545-0257
40.6302(c)-3(b)(2)(ii).....................................    1545-1296
40.6302(c)-3(b)(2)(iii)....................................    1545-1296
40.6302(c)-3(e)............................................    1545-1296
40.6302(c)-3(f)(2)(ii).....................................    1545-1296
41.4481-1..................................................    1545-0143
41.4481-1T.................................................    1545-0143
41.4481-2..................................................    1545-0143
41.4482(b)-1T..............................................    1545-0143
41.4483-3..................................................    1545-0143
41.6001-1..................................................    1545-0143
41.6001-2..................................................    1545-0143
41.6001-3..................................................    1545-0143
41.6071(a)-1...............................................    1545-0143
41.6081(a)-1...............................................    1545-0143
41.6091-1..................................................    1545-0143
41.6109-1..................................................    1545-0143
41.6151(a)-1...............................................    1545-0143
41.6156-1..................................................    1545-0143
41.6161(a)(1)-1............................................    1545-0143
44.4401-1..................................................    1545-0235
44.4403-1..................................................    1545-0235
44.4412-1..................................................    1545-0236
44.4901-1..................................................    1545-0236
44.4905-1..................................................    1545-0236
44.4905-2..................................................    1545-0236
44.6001-1..................................................    1545-0235
44.6011(a)-1...............................................    1545-0235
                                                               1545-0236
44.6071-1..................................................    1545-0235
44.6091-1..................................................    1545-0235
44.6151-1..................................................    1545-0235
44.6419-1..................................................    1545-0235
44.6419-1..................................................    1545-0235
44.6419-2..................................................    1545-0235
46.4371-4..................................................    1545-0023
46.4374-1..................................................    1545-0023
46.4701-1..................................................    1545-0023
                                                               1545-0257
48.4041-4..................................................    1545-0023
48.4041-5..................................................    1545-0023
48.4041-6..................................................    1545-0023
48.4041-7..................................................    1545-0023
48.4041-9..................................................    1545-0023
48.4041-10.................................................    1545-0023
48.4041-11.................................................    1545-0023
48.4041-12.................................................    1545-0023
48.4041-13.................................................    1545-0023
48.4041-18.................................................    1545-0023
48.4041-19.................................................    1545-0023
48.4041-20.................................................    1545-0023
48.4041-21.................................................    1545-1270
48.4042-2..................................................    1545-0023
48.4061(a)-1...............................................    1545-0023
48.4061(a)-2...............................................    1545-0023
48.4061(b)-3...............................................    1545-0023
48.4064-1..................................................    1545-0014
                                                               1545-0242
48.4071-1..................................................    1545-0023
48.4073-1..................................................    1545-0023
48.4073-3..................................................    1545-0023
                                                               1545-1074
                                                               1545-1087
48.4081-2(c)(3)............................................    1545-1270
48.4081-3(d)(2)(iii).......................................    1545-1270
48.4081-3(e)(2)(ii)........................................    1545-1270
48.4081-3(f)(2)(ii)........................................    1545-1270
48.4081-4(b)(2)(ii)........................................    1545-1270
48.4081-4(b)(3)(i).........................................    1545-1270
48.4081-4(c)...............................................    1545-1270
48.4081-6(c)(1)(ii)........................................    1545-1270
48.4081-7..................................................    1545-1270
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48.4082-2..................................................    1545-1418
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48.4161(a)-1...............................................    1545-0723
48.4161(a)-2...............................................    1545-0723
48.4161(a)-3...............................................    1545-0723
48.4161(b)-1...............................................    1545-0723
                                                               1545-0723
48.4216(a)-2...............................................    1545-0023
48.4216(a)-3...............................................    1545-0023
48.4216(c)-1...............................................    1545-0023
48.4221-1..................................................    1545-0023
48.4221-2..................................................    1545-0023
48.4221-3..................................................    1545-0023
48.4221-4..................................................    1545-0023
48.4221-5..................................................    1545-0023
48.4221-6..................................................    1545-0023
48.4221-7..................................................    1545-0023
48.4222(a)-1...............................................    1545-0023
                                                               1545-0014
48.4222(b)-1...............................................    1545-0023
48.4223-1..................................................    1545-0023
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48.6302(c)-1...............................................    1545-0023
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48.6412-1..................................................    1545-0723
48.6416(a)-1...............................................    1545-0023
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48.6416(a)-2...............................................    1545-0723
48.6416(a)-3...............................................    1545-0723
48.6416(b)(2)-3............................................    1545-1087
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48.6416(b)(1)-2............................................    1545-0723
48.6416(b)(1)-3............................................    1545-0723
48.6416(b)(1)-4............................................    1545-0723
48.6416(b)(2)-1............................................    1545-0723
48.6416(b)(2)-2............................................    1545-0723
48.6416(b)(2)-3............................................    1545-0723
                                                               1545-1087
48.6416(b)(2)-4............................................    1545-0723
48.6416(b)(3)-1............................................    1545-0723
48.6416(b)(3)-2............................................    1545-0723
48.6416(b)(3)-3............................................    1545-0723
48.6416(b)(4)-1............................................    1545-0723
48.6416(b)(5)-1............................................    1545-0723
48.6416(c)-1...............................................    1545-0723
48.6416(e)-1...............................................    1545-0023
                                                               1545-0723
48.6416(f)-1...............................................    1545-0023
                                                               1545-0723
48.6416(g)-1...............................................    1545-0723
48.6416(h)-1...............................................    1545-0723
48.6420(c)-2...............................................    1545-0023
48.6420(f)-1...............................................    1545-0023
48.6420-1..................................................    1545-0162
                                                               1545-0723
48.6420-2..................................................    1545-0162
                                                               1545-0723
48.6420-3..................................................    1545-0162
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48.6420-4..................................................    1545-0162
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48.6420-5..................................................    1545-0162
                                                               1545-0723
48.6420-6..................................................    1545-0162
                                                               1545-0723
48.6420-7..................................................    1545-0162
                                                               1545-0723
48.6421-0..................................................    1545-0162
                                                               1545-0723
48.6421-1..................................................    1545-0162
                                                               1545-0723
48.6421-2..................................................    1545-0162
                                                               1545-0723
48.6421-3..................................................    1545-0162
                                                               1545-0723
48.6421-4..................................................    1545-0162
                                                               1545-0723
48.6421-5..................................................    1545-0162
                                                               1545-0723
48.6421-6..................................................    1545-0162
                                                               1545-0723
48.6421-7..................................................    1545-0162
                                                               1545-0723
48.6424-0..................................................    1545-0723
48.6424-1..................................................    1545-0723
48.6424-2..................................................    1545-0723
48.6424-3..................................................    1545-0723
48.6424-4..................................................    1545-0723
48.6424-5..................................................    1545-0723
48.6424-6..................................................    1545-0723
48.6427-0..................................................    1545-0723
48.6427-1..................................................    1545-0023
                                                               1545-0162
                                                               1545-0723
48.6427-2..................................................    1545-0162
                                                               1545-0723
48.6427-3..................................................    1545-0723
48.6427-4..................................................    1545-0723
48.6427-5..................................................    1545-0723
48.6427-8..................................................    1545-1418
48.6427-9..................................................    1545-1418
49.4251-1..................................................    1545-1075
49.4251-2..................................................    1545-1075
49.4253-3..................................................    1545-0023
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49.4264(b)-1...............................................    1545-0023
                                                               1545-0226
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                                                               1545-0912
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49.4271-1(d)...............................................    1545-0685
52.4682-1(b)(2)(iii).......................................    1545-1153
52.4682-2(b)...............................................    1545-1153
                                                               1545-1361
52.4682-2(d)...............................................    1545-1153
                                                               1545-1361
52.4682-3(c)(2)............................................    1545-1153
52.4682-3(g)...............................................    1545-1153
52.4682-4(f)...............................................    1545-1153
                                                               1545-0257
52.4682-5(d)...............................................    1545-1361
52.4682-5(f)...............................................    1545-1361
53.4940-1..................................................    1545-0052
                                                               1545-0196
53.4942(a)-1...............................................    1545-0052
53.4942(a)-2...............................................    1545-0052
53.4942(a)-3...............................................    1545-0052
53.4942(b)-3...............................................    1545-0052
53.4945-1..................................................    1545-0052
53.4945-4..................................................    1545-0052
53.4945-5..................................................    1545-0052
53.4945-6..................................................    1545-0052
53.4947-1..................................................    1545-0196
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53.4948-1..................................................    1545-0052
53.4961-2..................................................    1545-0024
53.4963-1..................................................    1545-0024
53.6001-1..................................................    1545-0052
53.6011-1..................................................    1545-0049
                                                               1545-0052
                                                               1545-0092
                                                               1545-0196
53.6065-1..................................................    1545-0052
53.6071-1..................................................    1545-0049
53.6081-1..................................................    1545-0066
                                                               1545-0148
53.6161-1..................................................    1545-0575
54.4972-1..................................................    1545-0197
54.4975-7..................................................    1545-0575
54.4977-1T.................................................    1545-0771
54.4981A-1T................................................    1545-0203
54.6011-1..................................................    1545-0575
54.6011-1T.................................................    1545-0575
55.6001-1..................................................    1545-0123
55.6011-1..................................................    1545-0999
                                                               1545-0123
                                                               1545-1016
55.6061-1..................................................    1545-0999
55.6071-1..................................................    1545-0999
56.4911-6..................................................    1545-0052
56.4911-7..................................................    1545-0052
56.4911-9..................................................    1545-0052
56.4911-10.................................................    1545-0052
56.6001-1..................................................    1545-1049
56.6011-1..................................................    1545-1049
56.6081-1..................................................    1545-1049
56.6161-1..................................................    1545-1049
                                                               1545-0257
145.4051-1.................................................    1545-0745
145.4052-1.................................................    1545-0120
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145.4061-1.................................................    1545-0745
                                                               1545-0257
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156.6001-1.................................................    1545-1049
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156.6081-1.................................................    1545-1049
156.6161-1.................................................    1545-1049
301.6011-2.................................................    1545-0225
                                                               1545-0350
                                                               1545-0387
                                                               1545-0441
                                                               1545-0957
301.6017-1.................................................    1545-0090
301.6034-1.................................................    1545-0092
301.6035-1.................................................    1545-0123
301.6036-1.................................................    1545-0013
                                                               1545-0773
301.6047-1.................................................    1545-0367
                                                               1545-0957
301.6057-1.................................................    1545-0710
301.6057-2.................................................    1545-0710
301.6058-1.................................................    1545-0710
301.6059-1.................................................    1545-0710
301.6103(c)-1..............................................    1545-0280
301.6104(a)-1..............................................    1545-0495
301.6104(a)-5..............................................    1545-0056
301.6104(a)-6..............................................    1545-0056
301.6104(b)-1..............................................    1545-0094
                                                               1545-0742
301.6104(d)-1..............................................    1545-0092
301.6109-1.................................................    1545-0003
                                                               1545-0295
                                                               1545-0367
                                                               1545-0387
                                                               1545-0957
                                                               1545-1461
301.6110-3.................................................    1545-0074
301.6110-5.................................................    1545-0074
301.6111-1T................................................    1545-0865
                                                               1545-0881
301.6112-1T................................................    1545-0865
301.6222(a)-2T.............................................    1545-0790
301.6222(b)-1T.............................................    1545-0790
301.6222(b)-2T.............................................    1545-0790
301.6222(b)-3T.............................................    1545-0790
301.6227(b)-1T.............................................    1545-0790
                                                               1545-0790
301.6231(a)(7)-1...........................................    1545-0790
301.6241-1T................................................    1545-0130
301.6316-4.................................................    1545-0074
301.6316-5.................................................    1545-0074
301.6316-6.................................................    1545-0074
301.6316-7.................................................    1545-0029
301.6324A-1................................................    1545-0015
301.6361-1.................................................    1545-0074
                                                               1545-0024
301.6361-2.................................................    1545-0024
301.6361-3.................................................    1545-0074
301.6402-2.................................................    1545-0024
                                                               1545-0073
                                                               1545-0091
301.6402-3.................................................    1545-0055
                                                               1545-0073
                                                               1545-0091
                                                               1545-0132
301.6402-5.................................................    1545-0928
301.6404-1.................................................    1545-0024
301.6404-2T................................................    1545-0024
301.6404-3.................................................    1545-0024
301.6405-1.................................................    1545-0024
301.6501(c)-1..............................................    1545-1241
301.6501(d)-1..............................................    1545-0074
                                                               1545-0430
301.6501(o)-2..............................................    1545-0728
301.6511(d)-1..............................................    1545-0582
                                                               1545-0024
301.6511(d)-2..............................................    1545-0582
                                                               1545-0024
301.6511(d)-3..............................................    1545-0024
                                                               1545-0582
301.6652-2.................................................    1545-0092
301.6656-1.................................................    1545-0794
301.6656-2.................................................    1545-0794
301.6685-1.................................................    1545-0092
301.6689-1T................................................    1545-1056
301.6707-1T................................................    1545-0865
                                                               1545-0881
301.6708-1T................................................    1545-0865
301.6712-1.................................................    1545-1126
301.6723-1A(d).............................................    1545-0909
301.6903-1.................................................    1545-0013
301.6905-1.................................................    1545-0074
301.7001-1.................................................    1545-0123
301.7101-1.................................................    1545-1029
301.7207-1.................................................    1545-0092
301.7216-2.................................................    1545-0074
301.7216-2(o)..............................................    1545-1209
301.7425-3.................................................    1545-0854
301.7430-2(c)..............................................    1545-1356
301.7507-8.................................................    1545-0123
301.7507-9.................................................    1545-0123
301.7513-1.................................................    1545-0429
301.7517-1.................................................    1545-0015
301.7605-1.................................................    1545-0795
301.7623-1.................................................    1545-0409

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301.7654-1.................................................    1545-0803
301.7701-3.................................................    1545-1486
301.7701-4.................................................    1545-1465
301.7701-16................................................    1545-0795
301.7701(b)-1..............................................    1545-0089
301.7701(b)-2..............................................    1545-0089
301.7701(b)-3..............................................    1545-0089
301.7701(b)-4..............................................    1545-0089
301.7701(b)-5..............................................    1545-0089
301.7701(b)-6..............................................    1545-0089
301.7701(b)-7..............................................    1545-0089
301.7701(b)-9..............................................    1545-0089
301.7805-1.................................................    1545-0805
301.9001-1.................................................    1545-0220
301.9001-2T................................................    1545-1488
301.9001-3T................................................    1545-1488
301.9100-4T................................................    1545-0016
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301.9100-6T................................................    1545-0872
301.9100-7T................................................    1545-0982
301.9100-8.................................................    1545-1112
301.9100-11T...............................................    1545-0123
301.9100-12T...............................................    1545-0026
                                                               1545-0074
                                                               1545-0172
                                                               1545-1027
301.9100-13T...............................................    1545-0046
301.9100-14T...............................................    1545-0046
301.9100-15T...............................................    1545-0046
301.9100-16T...............................................    1545-0152
302.1-7....................................................    1545-0024
305.7701-1.................................................    1545-0823
305.7871-1.................................................    1545-0823
404.6048-1.................................................    1545-0160
420.0-1....................................................    1545-0710
Part 502...................................................    1545-0844
Part 503...................................................    1545-0837
Part 509...................................................    1545-0846
Part 513...................................................    1545-0834
Part 514...................................................    1545-0845
Part 516...................................................    1545-0841
Part 517...................................................    1545-0849
Part 520...................................................    1545-0833
Part 521...................................................    1545-0848
601.104....................................................    1545-0233
601.105....................................................    1545-0091
601.201....................................................    1545-0019
                                                               1545-0819
601.204....................................................    1545-0152
601.401....................................................    1545-0257
601.504....................................................    1545-0150
601.601....................................................    1545-0800
601.602....................................................    1545-0295
                                                               1545-0387
                                                               1545-0957
601.702....................................................    1545-0429
------------------------------------------------------------------------

(26 U.S.C. 7805)

[T.D. 8011, 50 FR 10222, Mar. 14, 1985]

    Editorial Note: For Federal Register citations affecting 
Sec. 602.101, see the List of CFR Sections Affected in the Findings Aids 
section of 26 CFR part 600-end.

    Effective Date Note: By T.D. 8712, at 62 FR 2275, Jan. 16, 1997, in 
Sec. 602.1, the table in paragraph (c) was amended by adding entries for 
Secs. 1.141-1, 1.141-12, 1,142-2 and 1.148-6, effective May 16, 1997.

[[Page 721]]



List of CFR Sections Affected



All changes to sections of part 1 (Secs. 1.641 to 1.850) of title 26 of 
the Code of Federal Regulations which were made by documents published 
in the Federal Register since January 1, 1986, are enumerated in the 
following list. Entries indicate the nature of the changes effected. 
Page numbers refer to Federal Register pages. The user should consult 
the entries for chapters and parts as well as sections for revisions.
For the period before January 1, 1986, see ``List of CFR Sections 
Affected, 1949-1963, 1964-1972, and 1973-1985'' published in seven 
separate volumes.

                                  1986

26 CFR
                                                                   51 FR
                                                                    Page
Chapter I
1.704-1  (b)(0) table, (2)(iv) (f)(1), (m)(3), and (5) Examples 
        (15) and (18) corrected....................................10826
    (b)(4)(iv) heading revised; (b)(4)(iv) text and (b)(5) 
Examples (20) through (23) added...................................32062
    (b)(1) (i) and (ii) amended....................................32068
    (b)(1)(iii), (2)(ii)(b), (d)(6), (f), (h), (i), (iii)(c)(2), 
(iv) (b), (c), (d)(3), (f) introductory text, and (f)(5)(ii) 
amended; (b)(2)(iv)(g)(3) and (m)(4) revised.......................32069
    (b)(0) table, (2)(iv)(j), (3) (i) and (iii), (4) (i) and (v), 
(b)(5) Examples (1)(ix), (7) (i) and (iii) (13)(i), (14)(i), and 
(18) (iii), (vii) and (viii) amended; (b)(2)(iv)(r) revised........32070
1.817-5T  Revised (temporary)......................................32634
1.819-5  Determination...............................................883

                                  1987

26 CFR
                                                                   52 FR
                                                                    Page
Chapter I
1.702-3T  Added (temporary)........................................48530
1.704-1  (b)(5) Examples (20) and (22) corrected; (b)(3)(ii) 
        correctly designated.......................................10223
1.706-1  (b)(7) added...............................................3623
1.706-1T  Added (temporary)........................................48995
1.807-1T  Added (temporary)...........................................39

                                  1988

26 CFR
                                                                   53 FR
                                                                    Page
Chapter I
1.702-1T  Added (temporary).........................................6603
1.704-1  (b)(0) table, (2)(ii)(c), (2)(ii)(h), (d)(6) amended; 
        (b)(4)(iv)(h) revised......................................53173
1.704-1T  Added (temporary)........................................53161
1.706-1T  (a)(2) and (d) Examples (2) and (5) corrected.............1441
    (a)(1) amended (temporary).....................................19711
1.706-3T  Added (temporary)........................................19710
1.752-0T  Added (temporary)........................................53143
1.752-1  Removed...................................................53143
1.752-1T  Added (temporary)........................................53143
1.752-2T  Added (temporary)........................................53160
1.752-3T  Added (temporary)........................................53160
1.752-4T  Added (temporary)........................................53160
1.755-2T  Added (temporary)........................................27044
    Comment time extended..........................................32899
1.832-4  Redesignated as 1.832-4T and amended........................118
1.832-4T  Redesignated from 1.832-4 and (a)(5) amended; heading, 
        (b) and (c) revised; (d) and (e) added (temporary)...........118
    Technical correction............................................3118

[[Page 722]]

                                  1989

26 CFR
                                                                   54 FR
                                                                    Page
Chapter I
1.702-1  (e) redesignated as (f); new (e) added....................13680
1.702-1T  Removed..................................................13680
1.704-1T  (b)(4)(iv)(m)(2) redesignated as (b)(4)(iv)(m)(4); 
        (b)(0) and (4)(iv)(m)(1) and new (4) amended; new 
        (b)(4)(iv)(m)(2) and (3) added; (b)(4)(iv)(g)(1) revised 
                                                                   48096
1.752-0T  Amended (temporary)......................................48094
1.752-1T  (d)(3)(ii)(B)(4)(ii), (v)(A), (vii) (A) and (B), 
        (h)(3)(ii) and (4), and (k) Example (13) amended; (h)(5) 
        added; (j)(3) revised (temporary)..........................48094
1.752-2T  (b) Example (1) amended..................................48095
1.752-4T  (b) revised; (c) through (e) redesignated as (d) through 
        (f); new (c) added; new (d) and new (e) amended............48096
1.807-1  Revised...................................................52934
1.807-1T  Removed..................................................52934
1.807-2  Removed...................................................52934
1.817-5  Added......................................................8730
1.817-5T  Removed...................................................8730
    (a)(1) corrected...............................................11866
1.832-4T  (d)(1) and (e) revised (temporary).......................38970
1.832-7T  Added (temporary)........................................38970

                                  1990

26 CFR
                                                                   55 FR
                                                                    Page
Chapter I
1.807-1  Table corrected............................................1768
1.832-4T  (d)(1) and (e) revised (temporary)........................9425
1.832-7T  Heading and (d) revised (temporary).......................9425

                                  1991

26 CFR
                                                                   56 FR
                                                                    Page
Chapter I
1.702-1  (f) amended...............................................21952
1.703-1  (a)(2)(vii) redesignated as (a)(2)(viii); new (a)(2)(vii) 
        added......................................................21952
1.704-1  (b)(0), (1)(i) and (2)(ii)(d)(6) amended; (b)(4)(iv) 
        revised; (b)(5) Examples (20) through (23) removed.........66983
1.704-1T  (b)(4)(iv) removed.......................................66983
1.704-2  Added.....................................................66983
1.752-0  Added.....................................................66350
1.752-0T  Amended..................................................36702
    Removed........................................................66350
1.752-1  Added.....................................................66351
1.752-1T  Removed..................................................66350
1.752-2  Added.....................................................66351
1.752-2T  Removed..................................................66350
1.752-3  Added.....................................................66355
1.752-3T  Removed..................................................66350
1.752-4  Added.....................................................66356
1.752-4T  (d)(2) and (f) redesignated as (d)(3) and (g); new 
        (d)(2) and (f) added.......................................36702
    Removed........................................................66350
1.752-5  Added.....................................................66356

                                  1992

26 CFR
                                                                   57 FR
                                                                    Page
Chapter I
1.702-1  (f) corrected..............................................4913
1.702-3T  (c) amended..............................................43896
1.703-1  Designation corrected......................................4913
1.704-1  Corrected..................................................6073
    (b)(2)(ii)(d)(6) and (iv)(r) concluding text corrected.........11430
1.704-2  (b)(4), (c), (e)(3), (f)(5), (7) Example 1, (g)(1)(i), 
        (i)(4), (j)(1)(iii), (k)(5), (l)(2)(ii) and (m) Example 3 
        corrected...................................................6073
    (a), (d)(4)(ii), (f)(7) Example 1, (g)(1)(ii), (j)(1)(i)(B), 
(ii)(B), (2)(i)(B), (ii)(B), (l)(1)(iii)(A), (3)(ii) and (m) 
Example 1 corrected.................................................8961
    (m) Example 1, Example 3, and Example 4 corrected...............8962
    (f)(3), (h)(1), (4), (l)(1)(ii) and (m) Example 4 corrected....11430
    (b)(4), (c), (e)(3), (f)(7) Example 1, Example 2 and (i)(4) 
corrected..........................................................28611
    (a), (d)(4)(ii), (f)(7) Example 1, (g)(1)(ii), (l)(1)(iii)(A) 
and (m) Example 1 and Example 3 corrected..........................37189
1.705-1  (a)(2)(iii) revised; (a)(4) redesignated as (a)(6); new 
        (a)(4) and (5) added.......................................43904

[[Page 723]]

1.707-0  Added.....................................................44978
1.707-2  Heading added.............................................44978
1.707-3  Added.....................................................44978
1.707-4  Added.....................................................44981
    (a)(3)(ii), (4) Example 1 and Example 2 corrected..............56444
1.707-5  Added.....................................................44983
1.707-6  Added.....................................................44987
1.707-7  Heading added.............................................44988
1.707-8  Added.....................................................44988
1.707-9  Added.....................................................44989
1.752-2  (b)(6) correctly designated................................4913
    (e)(1) and (g)(4) corrected.....................................5054
    (b)(2)(i), (d)(2), (f) Example 2 and Example 3 corrected; 
(b)(6) correctly designated.........................................5511
1.832-4  Redesignated from 1.832-4T; heading and (b) through (e) 
        revised; (a)(5) amended; (f) and (g) added..................3132
    (d)(2)(i)(a) correctly designated as (d)(2)(i)(A)...............6353
1.832-4T  Redesignated as 1.832-4...................................3132
1.846-0  Added.....................................................40843
    Corrected......................................................48563
1.846-1  Added.....................................................40844
1.846-2  Added.....................................................40845
1.846-3  Added.....................................................40845
    (f) Example 5 corrected........................................48563
    (f) Example 1 corrected........................................57531
1.846-4  Added.....................................................40847
1.848-0  Added.....................................................61818
1.848-1  Added.....................................................61819
1.848-2  Added.....................................................61821
1.848-3  Added.....................................................61829

                                  1993

26 CFR
                                                                   58 FR
                                                                    Page
Chapter I
1.704-1  (b)(1)(vi), (2)(iv)(d)(3) and (c) revised.................67679
1.704-1T  Removed..................................................67679
1.704-3  Added.....................................................67679
1.704-3T  Added....................................................67686
1.809-9  Added.....................................................64899
1.809-10T  Added...................................................47061
1.848-1  (h)(2)(vi) corrected.......................................9245
1.848-2  (k)(2)(ii) corrected.......................................7987

                                  1994

26 CFR
                                                                   59 FR
                                                                    Page
Chapter I
1.642(c)-6  (d)(2) amended.........................................30102
    (d)(1) redesignated as (d) and (d)(2) and (3) redesignated as 
1.642(c)-6A (d)(3) and (4); heading, (a), (b), (c)(1), new (d) and 
(e) revised; (f) added; authority citation removed.................30105
1.642(c)-6A  Undesignated center heading and section added; (d)(3) 
        and (4) redesignated from 1.642(c)-6 (d)(2) and (3)........30105
    (d)(4) table amended...........................................30116
1.642(c)-7  (d)(2) amended.........................................30102
1.664-1  (a)(6) Example amended....................................30102
    (a)(5)(ii)(b), (iv)(a), (b), (c), and (6) introductory text 
revised; (a)(5)(iv)(d) added; authority citation removed...........30116
1.664-2  (c) revised; authority citation removed...................30116
1.664-4  (b)(2) and (3) amended....................................30102
    (b)(1) redesignated as (b) and (b)(2) through (5) redesignated 
as 1.664-4A (d)(3) through (6); (a), new (b), (c) and (d) revised; 
(e) and (f) added; authority citation removed......................30117
1.664-4A  Undesignated center heading and section added............30116
    (d)(3) through (6) redesignated from 1.664-4...................30117
    (d)(4), (5), (6) heading, Tables D, E, and F(1) amended........30148
1.665(a)-0--1.669(b)-2  Undesignated center heading revised........30148
1.665(a)-0A--1.665(g)-2A  Undesignated center heading added........30148
1.704-1  (b)(1)(vi), (2)(iv)(d)(3) and (c) amended.................66728
1.704-3  (c)(4)  Examples 1 and 3 corrected.........................4140
    (a)(1) and (3)(i) amended; (d), (e)(2)(iii) and (3) revised; 
(e)(2)(iv) and (v) removed; (e)(4) added...........................66728
1.704-3T  Removed..................................................66734
1.761-2  Heading revised; (a)(3) concluding text amended; (d) 
        redesignated as (e); new (d) added.........................66183

[[Page 724]]

1.809-10  Redesignated from 1.809-10T and amended..................49579
1.809-10T  Redesignated as 1.809-10................................49579
1.848-2  (i)(4)(iii)(C) corrected....................................947

                                  1995

26 CFR
                                                                   60 FR
                                                                    Page
Chapter I
1.671-4  Revised...................................................66087
1.701-2  Added........................................................27
    (d) Examples 3, 7 and 9 amended.................................9776
    (d) Examples 10 through 13 and (f) Example 2 amended............9777
    (a)(3) and (f) introductory text amended; (d) Examples 5 and 6 
removed; (d) Examples 7 through 13 and (h) redesignated as (d) 
Examples 5 through 11 and (i); new (h) added.......................18741
1.704-3  (d)(7) Examples 1, 3, and (e)(3)(ix) Examples 1 and 2 
        corrected..................................................11906
1.704-4  Added.....................................................66730
1.737-1  Added.....................................................66733
1.737-2  Added.....................................................66735
1.737-3  Added.....................................................66736
1.737-4  Added.....................................................66738
1.737-5  Added.....................................................66739
1.751-1  (c)(4), (5) and (6) revised................................2500
1.761-2  (d)(2)(i) corrected.......................................11028

                                  1996

26 CFR
                                                                   61 FR
                                                                    Page
Chapter I
1.671-4  (a) amended...............................................19191
1.677(a)-1  (d) amended............................................19191
1.721-1  (c) added.................................................19189
1.731-2  Added.....................................................67938
1.737-3  (e) corrected..............................................7214
1.761-1  (a) revised...............................................66588
1.804-1  Removed.....................................................516
1.804-2  Removed.....................................................516
1.805-1  Removed.....................................................516
1.805-2  Removed.....................................................516
1.805-3  Removed.....................................................516
1.805-4  Removed.....................................................516
1.805-5  Removed.....................................................516
1.805-6  Removed.....................................................516
1.805-7  Removed.....................................................516
1.805-8  Removed.....................................................516
1.820-1  Removed.....................................................516
1.820-2  Removed.....................................................516
1.820-3  Removed.....................................................516
1.824-1  Removed.....................................................516
1.824-2  Removed.....................................................516
1.824-3  Removed.....................................................516

                                  1997

   (Regulations published from January 1, 1997 through April 1, 1997)

26 CFR
                                                                   62 FR
                                                                    Page
Chapter I
1.731-2  (j) Example 4 table corrected..............................8086